A good 1Q result for DLTR, but overall a negative event given the company’s large upward revision to 2021 freight cost expectations. Comps at Dollar Tree at +4.7% accelerating from 2.4% last Q on an easier compare. Maybe that’s slightly low in the context of strength across much of retail in 1Q, but remember that the company lost a lot of store days in core markets of Texas/Oklahoma from the storm impact in February (about one point in sales hit). Also the core Dollar Tree banner is more of a vehicle/foot traffic concept that people shop at when out and about, there’s really no ecom, so given we were still in the midst of high covid case rates and covid restrictions through most of 1Q some underperformance is reasonable. We suspect comps outperform as we see people getting out shopping more as the year progresses. We think this is one of the best stocks in retail to own on a Tail duration, and we like how the catalyst calendar is setting up for 2H21 and beyond. We’ll be hearing more about expanded Dollar Plus tests later this year, we’ll be entering a Macro environment in 2H21 where bigger cap and ‘staple-like’ names like DLTR traditionally outperform, and as we head into 2022 DLTR will have relatively easy sales and margin compares given storm and pandemic pressure YTD and lapping the freight headwind. Long term we see breaking the buck at Dollar Tree as perhaps the most powerful earnings lever in all of retail. When the earnings power starts to be realized we can see a stock of $125-$150 by year end, and $200+ over a Tail duration.
Freight Debacle
The big issue this quarter is the guidance around freight costs. More specifically the revision of the prior number last quarter to now nearly 3x the cost. Last quarter was $80mm-$100mm, or about $0.33 at the high end, focused in first 3 quarters, now it’s $0.70 to $0.80 of YY pressure in the last 3 quarters of the year. It’s around 80-90 bps of margin pressure. The problem is not the amount, but the fact that the company outlined the cost so specifically on the 4Q print, talked about ways it could be offset, and then came back this Q with a very different number. It’s almost as if management was hoping to have shipping container availability magically correct over a couple months, and instead it got a little worse. That is just not good expectation management, and the selloff on that is justified. For the sake of confidence in management, this revised guide now has to be right (if not conservative). We suspect the added cost comes from the company doing the right thing businesswise and setting up the necessary shipping to get the product it wants when it needs it to execute the fall/holiday selling season appropriately. Perhaps DLTR is being more proactive than other retailers in this aspect. We expect it will be a bigger theme across retail in coming months.
Messaging
Another knock this quarter is the messaging from the CEO. Last quarter his bullishness likely gave investors confidence that the incremental wage and freight cost pressures could easily be offset. This quarter it felt like he was trying to do the same thing, even though the guidance clearly shows he was wrong last Q. So when he goes on an off the cuff run of initiatives and positive margin callouts to highlight the opportunity vs the risk, it starts to make management sound defensive and less credible. We think it would be better to just acknowledge the forecasting error, be clear that the freight costs are highly unlikely to persist over the long term, and focus on the long term business direction and investments vs potential ways the next Q or two pressure could be partially offset. Too much time was spent on the call trying to sound reassuring vs detailing how the business investments will drive long term earnings.
It’s All About Breaking The Buck
We have highlighted how breaking the buck at Dollar Tree is perhaps the most powerful earnings lever in all of retail. It can drive a multifaceted impact on the P&L including a significant comp acceleration, at high incremental margins, aid in Family Dollar merchandise value creation, and reaccelerate the Dollar Tree banner unit growth story given higher box productivity rates. The test is now at 280 stores and has scaled into several new markets. The rollout to 500 might take a little longer than the prior August guidance, which is fine to do it right. Management is citing strong sell through in current test stores limiting multi price point inventory needed to add more stores. Apparently the buying for multi-price point items planned for 500 stores this year could satisfy the demand of just 300 stores, nearly double the sales volume the company expected. Bullish for the breaking the buck consumer value proposition. The company also noted that it is seeing strong reaction to Dollar Plus from all geographies and the entire spectrum of consumer income levels, $30k to $100k plus household incomes. Again, this supports our take that breaking the buck is not about raising prices, it’s about creating incredibly compelling value as Dollar Tree always has, just at different price levels. Of course the nice coincidental P&L benefit is rapidly rising ASPs in the store, at higher merch margins, and big SG&A leverage. The CEO said the test will be further expanded in 2022, with more details to come later this year, both of which are in-line with our timing expectations.
