In early March we said DLTR was one of the best names to own in all of retail, and it has sat at the top of our long list since. After all before Covid-19 it had the worse sentiment it had seen since the great recession, and throughout the virus disruptions it has been one of the few open retailers selling essentials that wasn’t trading at peak multiples. Expectations are now heading higher and the stock is re-rating upwards accordingly, so we’re definitely a little more cautious on the trend set-up, especially as we head into Macro Quad3 in 2H20. We’re still very much bullish on the long term optionality here. Dollar Tree has some real earnings growth levers with new stores, and breaking the buck. Family Dollar has gone from borderline irrelevant to perhaps a much brighter future from the comp and customer acquisition momentum under Covid-19. If management breaks the buck and we see it in stores by late-2021 we see upside to $140 within 12 months and $200+ over a tail duration.
For our Black Book from Feb DLTR | Is the Market Right to Cut Bait? CLICK HERE
Comp Trend
Family Dollar showed strength throughout the quarter delivering a 15.5% comp capitalizing on necessity demand and governmental support of the low income consumer. Management noted that H2 renovations at Family Dollar are still seeing 10 percent outperformance. Stimulus is helping Family Dollar for sure, perhaps that tailwind weakens as the year progresses, though checks are apparently being sent until early September. There is talk of a another round of stimulus, but it is expected to get much more resistance this time around from the Republican senate. Dollar Tree comps were about inline with expectations, down 0.9% as the company had signaled the weakness around Late March and into Easter season. Management noted party, candy, and Easter were a 490bps drag on total comp. The CEO has cited an improvement in the discretionary part of the business noting recent strength in crafts and YY comp growth in grad balloons. The company noted that it anticipates a strong value opportunity in closeouts in the coming months, which we think is spot-on. We think this is a big opportunity for traffic driving value creation, especially mixing in multi-price point options for Dollar Tree Plus.
Margins
Lots of margin puts and takes (moreso on the takes this quarter), we won’t re-iterate it all here, the CFO commentary pretty much covers it. Some headwinds will remain, some should moderate as the year goes on. One that was not clearly reviewed to keep in mind is the store closure and remodel costs. These were about 100bps on gross margin and 95bps on SG&A for Family Dollar in 2Q of last year that the company has been flowing through the P&L. Given the remodel rate looks to be down materially YY there could be some incremental margin capture there that wasn’t clearly signaled (it also might give some of that back later in the year if shifting remodels out into 4Q). Fuel and freight is the cost item that should definitely be inflecting from headwind to tailwind. Cass Freight Index is now down over 20% in April, fuel costs down 25% starting 2Q. Discretionary categories performing better means we should see less mix impact in upcoming quarters. Distribution center costs likely remain elevated with the company chasing demand in necessity categories, and we do have some concern about how much of incremental compensation will have to stick, vs being considered one time. Employees likely won’t want a de-facto pay cut in the future, but perhaps management’s bargaining power will be stronger when the labor market isn’t as tight (vs 2019) and unemployment benefits wear off (ie more people will have to be looking to go back to work in 2H).
Quad 4 to 3
In early March, we highlighted the macro pivot to Quad 4, and that DLTR outperforms in that framework. The problem now is our Macro team thinks we are pivoting to Quad 3 in 2H, and that is the quadrant DLTR performs the worst in as inflation accelerates but real growth slows.
Tail Bull Case, Breaking the Buck
What was clearly missing from this event was commentary around the Dollar Tree Plus test. It was not mentioned at all. What had been perhaps the main narrative for the stock is now clearly on the back burner as it relates to management’s focus. That makes sense given what has to be managed right now day to day. However we still think this is the biggest value driving opportunity for the company. The math on the potential comp and margin impact of higher price point options speaks for itself (see our deck for details). Though we are not modeling a larger scale multi-price point rollout until late 2021, perhaps the near term opportunity in closeout merchandise will give DLTR an excuse to at least grow the test with very high value product offerings sooner than we expect. A Family Dollar turnaround is another potential value driver. It was approaching irrelevant but perhaps the comp and customer acquisition momentum under Covid-19 means the future is brighter there than it was 3 months ago. We're not banking on that, but it's definitely a net bullish development.
