The DLTR quarter was solid. 20% EPS beat, 45% EPS growth. Rate of change in Family Dollar sales moderated vs last Q and the sales slowdown continues QTD with the company noting each month from May seeing lower growth. That is to be expected from everything we heard in lower end retail for 2Q and August with lower governmental benefits month over month. Margins at Family Dollar were solid with a shift towards discretionary this Q, as well as leverage from the 11.6% sales growth. On the Dollar Tree side comps accelerated to 3.1% this Q as discretionary items recovered. Management noted some drag in consumables with inventory flow issues in certain items. Management implied QTD is going well for Dollar Tree so far as well. Freight was a margin help this Q, but incremental costs in wages/SG&A are where the street might be seeing risk vs prior expectations. The company had been perhaps prepping investors by repeatedly announcing the wage increase extensions, though total wage and incremental Covid costs pressure was about 2x of last Q at $135mm. Excluding that SG&A is only up 2% on solid comps, but the elevated costs should continue for at least another quarter, and probably into 4Q.
The call on the stock from here is still very much around the breaking of the buck. Commentary this Q was positive on the dollar plus test, after being left out of the story last Q. New CEO Michael Witynski said “Now regarding Dollar Tree Plus! Our focus on selling great value merchandise at price points of $5 and below, we are continuing to analyze, learn and make adjustments to the program. Earlier this year, we transitioned from the initial consumable-dominated assortment to more of a wild-type discretionary products that Dollar Tree is known for. We recently added bins to our larger test stores to promote some hot, one-time item sales. Sales of these discretionary products remained strong with good sell-through as customers are responding favorably. We are excited about the many new, multi-price discretionary products that we already have on the store shelves for this fall selling season. We remain encouraged about the potential for Dollar Tree Plus!”
Also in Q/A he outlined key metrics management will watch around the test including customer response, 4-wall productivity impact, and margin improvement as the test product continues to be enhanced. Below is a slide from our DLTR black book earlier this year of how we expected the test to progress, and we think we are in the middle stage where more of the product carries compelling value and should drive better customer reaction and comp upside in the respective stores. We are recently seeing products with more compelling value in the tests. But for some products, buys will need larger order volumes to extract worthwhile value, yet the test is still small in terms of the total store footprint, so it needs to be expanded to further enhance the product offering and to actually see an impact on the P&L. We think we should hear something to that effect by early 2021, and should start to see some P&L benefit by 2H2021, with still larger rollouts and larger assortment levels meaning further comp upside in future years. With various cost pressures in the model and further expected inflation, we think there is no better time to be pulling the multi-price point lever.
With no more clarity/action on the breaking of the buck, the stock probably trades +/- $10 from here, with probability perhaps favoring the downside. With progress in the test and further rollout, we see upside to $140 over 12 months, and $200+ stock opportunity over a TAIL duration.
