We made Dollarama a Best Idea long on April 15th as we felt we had visibility to accelerating comp growth with the company likely to pull pricing levers in the next 12-18 months. With the stock up 20%, the market is starting to recognize that call, but it still has plenty of room to run and we’d buy it today on that call alone. Now today the company has added another layer to the long case. The decision to buy Dollarcity looks like a no brainer given the transaction details. It creates value with long term optionality at a great price yet does not change the company’s strategic direction nor our investment thesis. DOL can now present a larger TAM beyond the Canadian market giving the growth story many more years of runway.
For our latest note after the DOL quarter: CLICK HERE
For our full thesis see our April Black Book Replay: CLICK HERE
Dollarama announced that it is exercising its call option to purchase a majority stake in Dollarcity, several months earlier than the option exercise date. The reasons to like the announcement include the differential between Dollarama’s valuation and the 5x multiple for Dollarcity, the acceleration in store growth rate, and the additional white space for future store expansion.
Transaction details (in US dollars, not Dollarama’s functional currency)
- Dollarama is exercising its call option to acquire 50.1% of Dollarcity. The purchase price is 5x EBITDA. The projected amount is expected to be between $85-95mm.
- Dollarama will add Dollarcity’s net income to its EBITDA. Dollarama will not consolidate Dollarcity’s sales, COGS, and SG&A in its P&L.
- Dollarcity’s owners have a put right in 2022 (three years after the closing of this transaction) to sell the remaining ownership to Dollarama. The multiple will be a market multiple. Based on the current range of retailers in Central and South America the multiple will likely be several turns higher.
- The transaction is expected to close in August.
Dollarcity background
- Dollarcity has 180 stores which represents 13% of the store base when included with Dollarama’s store base. Dollarcity is opening 40-50 stores this year which represents 3% of the combined store base and reach 600 by 2029.
- It was Bain’s idea to leverage Dollarama’s buying organization to start a similar retail operation in Central and South America ten years ago.
- Dollarama has been providing sourcing functionality particularly for hardgoods imported from Asia while Dollarcity has been sourcing most of its consumables locally.
- The banners have a lot of similarity. The price points translated to US dollars are about the same. Even the green and yellow used in Dollarama’s brand and signage is similar. Both banners have limited direct competition .
- Dollarama sold sourced items to Dollarcity at cost with a small markup for handling fees. The small markup was a 30bps drag on Dollarama’s gross margins.
- At 6,500 square feet on average the Dollarcity store size is smaller than Dollarama’s Canadian stores. Dollarcity has an AUV of $1.4mm and sales/psf of $215.
- Dollarcity’s EBITDA margin is lower than Dollarama’s, but still greater than 10%.
- In 2016 both companies agreed to push the option exercise date out by a year until more could be learned about Dollarcity’s success in a larger country. At the beginning of 2017 Dollarcity only had three stores in Colombia. In a little more than two years Dollarcity has 82 in Colombia. Management did not provide much color about what they have seen in Colombia in such a short period, but investors would likely be just as encouraged.
- The agreement with Dollarcity also includes Costa Rica, Ecuador, Honduras, Nicaragua, Panama and Peru. Although management said Colombia is the focus of Dollarcity's growth plans over the next ten years there is no reason to think it couldn't expand to the other countries in the future.
- Due to lower real estate costs the payback period is similar to Dollarama.
Pros
- Accelerates global store growth rate by 3%.
- Increases buying scale.
- An attractive multiple with Dollarama trading at close to 16x consensus EBITDA so it makes a lot of sense to acquire EBITDA at 5x, especially as other Latin American retailers are trading at 7x+.
- Accretive by C$.05-.07 on an annual basis, C$.02-.03 for the remainder of this year.
- There could be as many as six additional countries for future store growth, but the current growth plans focus on Columbia.
Cons
- Increases Fx volatility vs. the US dollar as Central American currencies are more sensitive to fluctuations.
- Introduces more operational risk by expanding outside Canada.
- Introduces more political risk from countries that have larger implications from changes in government leadership.
- Creates some operational risk with Dollarcity having opened a significant number of stores in a very short period in Colombia.