We struggle to find a name in retail we’d like to own more today than DLTR. If we think about the setup from here, with the guide down which included a greater ‘greater’ impact from remodels than we were expecting, it still implies EPS up YY, with no stock repurchasing baked in (ie EPS growth will be higher). It's hard to find a retailer with real EPS growth at the DLTR multiple. Sales shouldn’t be as volatile in a consumer down turn than much of the rest of retail as DLTR is the type of business that holds up as the consumer weakens. It historically outperforms in Macro #Quad4. And it should be a store where people are shopping to stock up on ‘necessities’ as US prepares for coronavirus self-driven quarantining, with 1H compares being similar or easier on most lines. Unlike many of the retailers selling off lately, DLTR has some real earnings growth levers with new stores, and breaking the buck. The test is evolving and given the new sourcing decisions put into Plus 2.0 its hard to argue management isn’t serious about the test for the long term. It is still moving slower than we’d like to see, but it is still moving clearly in the right direction, and the earnings power optionality is not being priced in. The sudden margin pressures seen over the last year highlight the need and opportunity of Dollar Tree being about to price/sell items outside of the $1 price point. We think there is no better time than now to test and implement the multi price point strategy. We admit Family Dollar isn’t looking good, but it’s also not very relevant for the stock here at ~10% of EBIT. Yet we still believe there should be inherent value in the possibility of management making changes to get comp growth and margin expansion within the business, that is also not in the stock today. Though there is no specific reason for the stock to start ripping tomorrow, if rate of change on fundamentals is likely to improve in the coming couple quarters, long term earnings expectations are too low, the price presents a good entry point, and the stock syncs with our Macro Quad outlook, that is a clear recipe for a Best Idea Long today. If management breaks the buck and we see it in stores by mid-2021 we see upside to $140 within 12 months and $200+ over a tail duration.
For our Black Book on DLTR from last month: CLICK HERE
#Quad 4
With equity market volatility spiking and much of retail seeing double digit percentage drops in the last couple weeks, the market is signaling Macro Quad4 and a likely continued consumer slowdown. If that environment for the majority of consumer multiples just go lower and lower. However some pockets of retail thrive, those that are more ‘staple like’ and sell necessities at affordable prices are good places to be. DLTR fits in that bucket and has historically performed very well in weak consumer environments of Macro Quad4.
Guidance Isn’t as Bad as it Looks
Management is guiding 2020 to a range of $4.80-5.15 vs. consensus of $5.25 and our estimate of $5.15. Included in management’s guidance is a $0.20 headwind from tariffs ($47mm) and ocean freight ($15mm) expenses. We contemplated both headwinds in our estimate, but underestimated the impact.
Family Dollar will renovate 1,250 stores in the H2 format compared to 1,150 in 2019. We modeled some YY benefit in 2020 thinking there would be less remodeling expense.
The tariffs are not a one-time expense, but with time to adjust sourcing, Dollar Tree should be able to pass on the expenses or adjust the item so that the tariffs are no longer a margin headwind.
The difference in management’s guidance and our estimate can be explained by those factors.
Q4 comp miss, but not EPS
After Five Below pre-announced weaker holiday sales after Black Friday due to fewer shopping days investors were concerned that Dollar Tree would miss Q4 EPS as well. Instead EPS was above expectations while the biggest disappointment in Q4 was the comp miss with overall comps up 0.4% vs. expectations of 1.8%. Both banners missed SSS expectations. Family Dollar comped down in November and December slightly while January was even weaker as it lapped the early SNAP benefit timing last year. For Dollar Tree the fewer holiday shopping days was the biggest sales headwind. Many retailers that are not holiday destinations but depend on holiday traffic in Q4 saw sales shortfalls with the fewer days between Thanksgiving and Christmas and Dollar Tree was no different. In 2020 Family Dollar’s SSS will be challenged by anniversarying Red Tag sales in renovated stores in 2020, but will benefit from H2 remodels. Family Dollar sales psf and sales per store still increased in Q4 despite the negative comp due to the closures and renovations. Without the calendar headwind we expect Dollar Tree SSS to at least return to +2-3%, the lower end of its long term trend, driven by the focus in several new merchandise categories and lapping the helium shortage.
Dollar Tree margins will depend upon SSS with less headwinds in 2020
Dollar Tree gross margins contracted 90bps. Tariffs were a 65bps headwind, occupancy was a 35bps headwind, distribution was a 15bps headwind, and shrink was a 10bps headwind, while freight was a 25bps tailwind.
The SG&A rate for Dollar Tree increased 40bps driven by payroll cost pressure of 30bps and higher credit card fees of 10bps.
With domestic freight costs no longer a headwind Dollar Tree should see margin trends flatten after incurring the higher tariff costs in the 1H of 2020. With smaller headwinds margins will be driven by SSS leverage.
Coolers, snackzones, and Crafter’s Square are the current sales drivers, but their contribution would pale in comparison to higher priced goods sourced by Dollar Tree merchants in discretionary categories.
Family Dollar margin headwind from store projects will inflect in 2020
Family Dollar gross margins expanded 100bps due to cycling a markdown reserve in the prior year. Merchandise costs decreased 60bps driven by IMU and freight while occupancy costs were 35bps higher, distribution costs up 15bps, and shrink was up 10bps.
The SG&A rate for Family Dollar increased 20bps due to D&A deleverage of 15bps and 10bps of higher credit card fees.
Family Dollar will remodel 1,250 stores in the H2 format in 2020, compared to 1,119 at the end of 2019. Closings and re-bannering Family Dollar stores should drop from a combined 600 in 2019 to 100 closings and a much smaller number of re-bannering projects which should be a margin tailwind from lower markdowns in 2020.
The H2 remodels are still driving sales increases of 10% which implies the older format stores had a comp decrease between 2-3% in Q4. Two-thirds of the lift from the remodels are from traffic growth.
Dollar Tree Plus! merchandise will soon reflect more Dollar Tree buys instead of Family Dollar buys
Management said it will launch Dollar Tree Plus! 2.0 in 2020. Dollar Tree will introduce 20 new sections in the store in the electronics, craft, health & beauty, seasonal, and toy sections while shifting away from consumables which were sourced from Family Dollar. The new sections are in the merchandise categories that we were most excited about in our visit to a few of the Plus! test stores. Two-thirds of the sections will be introduced to the test stores in March with another one-third in April followed by a couple additional sections in October. We predicted/suggested that Dollar Tree would emphasize merchandise categories in which it has a merchandising advantage over the competition while de-emphasizing consumables merchandise it brought over from Family Dollar stores. We think Dollar Tree will enjoy much more success in these categories, because that is where it currently excels and creates value for its customer. The pace of the test so far does suggest it would be difficult to expand the number of stores with Dollar Tree Plus! merchandise materially until the 2H of 2021 at the earliest. This is a management team that tests and learns and has long merchandise lead times. However, if management were to announce a significant expansion in the Plus! 2.0 roll out investors would discount the benefit to comp and margins immediately. The benefit from a higher price point roll out would be significantly more accretive than any other roll out like coolers, remodels, or snack zones. The simple math of higher price points makes a compelling case for the roll out.
