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Kevin Kersten's Analyst Insights  
 


InvestorsObserver
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Kevin Kersten
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September 30, 2013 - Do You Appreciate the Value of a Dollar Store?

The last few years have been hard on the majority of Americans. Unemployment and underemployment have been way too common and money doesn't just grow on trees. People have been looking to stretch their dollars, especially mothers. For example, if you have a couple of kids that want toys and money is tight the dollar store offers an easy solution. You can buy each of the kids a toy -- any toy they want in the whole store -- and you know exactly how much it will cost.

Given the economic conditions, discount retailer stocks have been performing very well for the last few years. Walmart (WMT), America's largest retailer, has benefited as have a host of dollar stores. Dollar Tree Inc (DLTR) is one of the dollar stores that has done well. Dollar Tree is different from Dollar General (DG) and Family Dollar (FDO) in that that everything in the store is one dollar or less. It is a convenient way to shop and a convenient way to sell: you don't have to compare price tags and they don't have to create or manage price tags! Last year, Dollar Tree sold about 7.4 billion items in its 4,671 stores in 48 states.

Dollar Tree has a nice niche in retail. It is not trying to sell everything to everybody, but it does try to sell something to everyone.  Customers shop the Dollar Tree for cheap good, and they deliver in a simple way.  Without having to worry about price tags, product placement on the shelf or setting of complex merchandising setups, products get onto the shelf with very little work required. If you have some shopping to do, chances are you can find many useful items at Dollar Tree and there may be many people who stop there before going to Wal-mart.  It's true that you get what you pay for and quality of goods at a Dollar Store may be lower than you would find elsewhere; but it can be a great place to shop for disposable items, Halloween decorations, seasonal goods or party supplies. When it comes to something like Halloween costumes, quality is less important than price to many consumers.

With an average item sold for a dollar, the company buys it at $0.64, creating net margins of 35.9%. Less than 10% of Dollar Tree merchandise is closeout specials from other stores. Most have been manufactured just for the store by one of its partners. Consumable goods make up 51% of the purchases with seasonal goods another 5%. Just over half of the merchandise is manufactured domestically with the remaining 45% coming from overseas. Over the last few years, refrigerated goods have been moving into the stores with 2,550 stores featuring coolers.  The company has been growing sales at about a 12.3% annual rate over the last three years. The company has been opening new stores, growing square footage at 7.7% a year.  Same store sales are expected to grow 2.6% next year after 3.0% growth this year.

Dollar Tree is seeing profits grow. Sales have moved up from 4.6 billion in 2009 to 7.3 billion this year. Earnings grew from 0.84 a share to 2.68 in the same time frame. These profits are going back into the company as a $2 billion dollar share repurchase program was authorized. Given that the entire company is worth $12.9 billion in market capitalization, this share repurchase is taking 15% of the company off the market. Another way of looking at it is remaining shares should appreciate 15%. The company's stock has had two splits in the last four years and currently trades near $58 a share.  Three years ago the stock was just over $20 a share. About 13% of Long Term Capitalization is debt and the company last year had a stunning 41% return on equity. These are great numbers that show there is real value in the Dollar Tree. Maybe money does grow on trees?


Stock Chart Courtesy of Stockcharts.com

With the harder times, Dollar Tree has seen discretionary purchases fall as a percent of the total business. Many middle- income consumers may also be trading down in the current economy. Given the demographics of option investors, chances are if you are reading this article you don't need to shop there, but many readers could may be the frugal type.

Dollar Tree seems to be doing really well. While the economy could improve and see consumers switch over to higher-class shopping, habits change slowly. Consumers are not indicating a big change in sentiment or shopping practices any time soon.

Dollar Tree does an exceptional job of bringing merchandise to the consumers, but it does not pay a dividend. Having a stock that has seen significant growth over the last few years in your portfolio is tempting. The stock buyback program should provide some price support as well. One can also pull in some extra money by writing a covered call. With the stock at 57.44 a share the 57.50 January call has a bid of 2.95 and an ask 3.10. Entering at a 54.49 (57.44-2.95) net debit the covered call has a 5.5% assigned return over the next 114 days. Annualized (for comparison purposes only) that is a 18% return. The trade has 5.2% of downside protection. For each share you own, selling a covered call could almost allow you to buy three new items at the Dollar Tree.

While most people who go to the Dollar Tree to save money are on a tight budget, investors might profit from their frugal habits. Dollar Tree's simple model, growing sales and excellent retail strategy has been thriving in the hard times seen recently. There is some real value in investing and shopping at the Dollar Tree. Maybe money does grow on Dollar Trees?

 

 

Articles and other Content

Julian Close - Dollar General: a growing power in discount retail

Michael Fowlkes - Use cost-conscious consumers to your advantage

Bobby Raines -Family Dollar is cheap, but doesn't mean you can't find some good value

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