THE HEDGEYE EDGE
Below is our outline on the Dollar Tree (DLTR) long thesis:
The greatest opportunity for a productivity boost for the Family Dollar banner is through merchandising, including empowering store managers to make some assortment decisions, reducing/fixing SKU assortment and leveraging the Dollar Tree buying organization to offer impressive value that will drive traffic and sales. At the Dollar Tree banner we see accelerating sales and margin expansion over a multi-year timeframe from introducing multi price points above $1. Implementing the changes could unlock a double in the share price from here.
INTERMEDIATE TERM (TREND)
In January activist investor Starboard Value pushed the company to sell the underperforming Family Dollar banner and introduce price points above $1 at the Dollar Tree banner. Management responded to the outside pressure by ruling out the Family Dollar sale, but seemingly adopting the multi price points. The board added three new independent members while management accelerated a store remodel campaign at Family Dollar. Last month Starboard removed its nominees for directors on DLTR’s board. The fund said in light of the constructive conversations with management and the promises made to test shareholder value enhancing initiatives including raising the $1 price point that new directors were no longer needed. A distracting and costly proxy contest was thus avoided.
Management is headed down the path of the greatest value creation opportunity as we outlined in our original black book last September, breaking the buck and fixing FDO. Selling FDO was part of the easiest path for an activist, but not the way to create the most upside. Management has a number of initiatives to close the profitability gap between the Family Dollar banner and Dollar Tree banner as well as competitor Dollar General. The current focus is on the consolidation of the two headquarters to facilitate synergies as well as a store remodel program to improve many of the merchandising and real estate underperformance. These initiatives require some time in order for the cumulative number of store updates to reach a critical mass where overall results are impacted. In other words, management has time to show progress.
With EPS guidance set so low a meaningful quarterly miss has likely been avoided while upside has likely been set-up. Since guidance was set so low for inventory clearances and costs to implement the store renovations a margin miss is much less likely. So the only way for DLTR to really disappoint investors is if Family Dollar comps hit a wall and comp down meaningfully as a near term acceleration is not expected. Otherwise it is difficult to see what would realistically disappoint shareholders from here. Being a dollar store, shares of DLTR are unlikely to sell-off if the outlook for consumer spending weakens. Of course, if Dollar Tree had a comp miss that would be disappointing, but that is the bet I am very willing to make.
Last week the Trump administration announced further tariff increases. For Dollar Tree the tariff change is a headwind, but it is already in guidance. Management noted on the 4Q call “The outlook Kevin will share is based on tariffs going to 25% as was the expectation when we built our annual business plan in both product through the back half of the year. If tariffs do not increase, we could see margin opportunity, primarily in the back half.” There could be a positive outcome from tariffs for Dollar Tree in that it may create greater urgency to break the dollar price point. Tariffs would also provide the company an external factor to point to when introducing the price point that customers would understand.
Long Term (TAIL)
One is hard pressed to find any retailer with the word ‘dollar’ in its name that has not actually given in and realized that inflation is real and subsequently broken into price zones above a buck. The best example is Dollarama. By raising the maximum allowed price point in a staged and pragmatic way, the retailer has been able to break into new categories like electronics, beauty and baby – something that Dollar Tree cannot do today.
This distinction is critical – I’m not talking about raising prices on like-for-like items, but rather giving the opportunity for consumers to experience the same kind of value proposition that a world class buying organization can bring to new categories. After a decade, Dollarama is flirting with a $5 price point, by way of new category offerings – though roughly 40% of its store is still at a US $1 price point equivalent.
If you ask Dollarama management about the 10-year strategy, they’d say if anything that they should have moved faster. As evidenced by the traffic numbers, it drove NEW customers to the store and did not alienate what was then the core customer. It turned Dollarama into one of the most consistent compers and share gainers. Based on the superiority of the Dollar Tree buying/sourcing organization – which is admittedly the best in the business – it’s my bet that it could put Dollarama to shame as it relates to succeeding in this arena.
Breaking the buck while maintaining its consumer value proposition results in a 10-year accelerated comp story, opens up unit growth opportunity, and adds $2-3 per share in TAIL earnings. Introducing higher price points over several years represents the largest EPS opportunity for the company with the lowest associated risk. If management can also turnaround its Family Dollar banner it could put a $230 stock in play in the out years. That’s the core reason to own the stock today.