There’s a lot going on in this earnings print for DLTR. 2Q EPS ahead of expectations but revenues light. The Dollar Tree comp trends are oddly weak in the context of the rest of retail. Management is pointing to the traffic/mobility trends, which we agree is a drag, likely along with still elevated e-commerce penetration levels. Perhaps that is persistent pressure for DLTR (likely will depend how pandemic continues to evolve) or one that makes for easy underlying sales compares in 2022. The bigger issue for DLTR is the guide down, the third in a row, on freight costs. The company clearly has no visibility on the direction of costs more than a month or so out. Even after locking in contract rates, those partners are simply not delivering anywhere near their commitments, meaning DLTR has to make it up on skyrocketing spot rates and pricey chartered ships. The frieght impact is now up to $1.50 to $1.60 in EPS or roughly $460mm for 2021 vs 2020. DLTR of course, unlike the rest of retail, can’t take up AURs to adjust. The ‘good news’ is the underlying earnings excl freight is $6.90-$7.20, though who knows exactly when/if freight costs go back down. This quarter we at least thought management had an improved tone around the issues. In the last couple quarters the new CEO appeared to proclaim blind optimism around the sales opportunity for the year, seemingly trying to reassure the market into a higher stock price, while being wrong both times. This quarter the expectations and tone were much more grounded, and the optimism was around the strategy and the execution, which is where a CEO actually has control and should have confidence. Management is also deploying capital in what we think is a wise way with accelerated buyback at these depressed EPS/stock levels, buying $700mm worth this Q around $100/sh. The company has another $1.45bn on the current authorization to buy more after this selloff. With all of retail seemingly buying back stock on recent peaky blowout EPS and peak stock prices, it's nice to see one buying at depressed levels before what should be a multi-year run in elevated EPS growth. The trend model is rough, and given port/freight issues are ongoing, who knows if the company will see even further freight issues. But the freight situation won’t last forever, and looking towards 2022 DLTR has one of the best earnings setups in all of retail. It has easy revenue compares, lapping huge abnormal cost pressures, and has a earnings catalyst of a scaling the multi-price point model to another 1500 stores on its way to 5000. As many retailers will be seeing falling earnings next year, DLTR will likely be a grower and investors will take note. This stock remains and Best Idea Long as we think that the Street is underestimating TAIL earnings power and the impact of ‘breaking the buck’ by over 40%. If it succeeds in the rollout, which we think it will, this stock should top $200. We’re big buyers on today’s selloff.
Dollar Plus & Breaking the Buck
A core reason this stock got elevated on our Best Ideas list and remains there is that the Dollar Plus initiative is playing out much like we expected. When the announcement of an expansion in the Dollar Plus test to 500 stores hit late last Fall, we knew management was serious about going forward vs just feigning an initiative to get an activist off its back. At that point, we expected to hear about a larger expansion by late 2021, and today the company announced that 1500 more stores are coming in 2022, and ultimately 5000 stores by 2024. This is big, as the most powerful earnings lever in all of retail has finally been pulled, and we’ll start to see some real impact on the P&L in 2022 and beyond. Management shared some metrics around test results noting a 6% sales lift, similar lift to gross profit, and improved cash contribution of approximately 13%. The 6% seems low to us. Though the company has to low ball this number, under promise and over deliver vs put too big a lift number out there. We think that the real impact on full rollout/scale has the potential to end up looking like a 40% lift.
The 6% lift is dependent on the amount of the store being converted. We don’t know the exact square footage of the test changeover, but stores we saw were in the 5-10% range. Generally, given our research on Dollarama’s breaking of the buck, for Dollar Tree we think a 10% changeover should see at least a 15-20% sales lift, at accretive merch margins. Also we expect conversion on the Dollar Plus offering to improve as the value proposition improves with scale (per our chart below). DLTR needs the store count scale to get the right buys/orders to drive peak customer value. The ratio of the store above $1 can also grow over time, and the velocity should grow as the company gets better at driving value at those price points. Longer term, the elevated sales levels means DLTR can further grow units as deals start to meet closing thresholds with better economics.
When investors start to see the earnings power around late ’21 to ’22 we see a stock of $125-$150, and $200+ over a Tail duration as breaking the buck flows through the P&L.
