This DLTR quarter had its puts and takes. Near term sales and margin pressures have developed around freight and weather disruptions, though the market was likely pricing this in prior to the event as they were well telegraphed in retail earnings season to date. Rate of change slowed on revenue and EBIT, with Dollar Tree comps coming in light from both foot traffic pressure amid rising Covid cases and stores being closed on Christmas. The trend is not overly bullish, though DLTR still delivered 19% EPS growth on 7.2% sales growth, very much deserving of its mid to high teens multiple. More importantly, everything within the report and commentary suggests that ‘breaking the buck’ is on track. Management has started the 500 store test expansion, and expects it to be completed by August. We suspect we’ll hear about more positive results in 2H earnings events. Additionally, management is talking about selling Dollar Plus items in FDO stores and within the newly announced dual store format, which further supports upscaling of the initiative. This is the most important element of the Tail bull case, and the probability of executing it continues to rise given company commentary and the necessity for maintaining the consumer value proposition perpetuated by inflation observed in Macro data. Breaking the buck could drive a significant comp acceleration, at high incremental margins, and reaccelerate the Dollar Tree banner unit growth story given higher box productivity rates.
Management didn’t provide specific guidance details but did comment around YY cost pressures and recent sales disruptions. The weather issues in Texas and other nearby areas cost the company 5500 store days in 1Q, which equates to about 75bps to 100bps of sales pressure for 1Q. We do expect sales to start accelerating given the easy compares of March 2020 amid shutdowns and the near non-existent Easter season last year. On the cost line, management is guiding $45mm to $50mm in wage inflation pressure for the year. Management clarified that it sees this pressure nearly every year as various states see their own min wage rise, but it generally doesn’t break it out as it's baked into more detailed margin guidance. Management also noted $80-$100mm in incremental costs from freight with 80% of that being on imports via port congestion, 20% on domestic freight rates. The company expects to offset this roughly 40-60bps of pressure with productivity gains and cost savings initiatives. Management also sounded bullish on the opportunity of 2021 sales despite tougher compares for FDO, so with the cost pressures being signaled and the weather sales impact being quantified, what’s the negative catalyst from here? If we do get a further Dollar Plus rollout around the timing we expect (late ’21 into early ’22) we could see a big ramp in comps on top of easy revenue and margin compares. The setup heading into 2H 2021 looks very bullish. The board just increased the share repurchase authorization to $2.4bn and given where we think the earnings are headed over a 2-3 year basis, we’d say it's prudent to buy back aggressively at current levels.
The last key callout is FDO. We have highlighted how the pandemic demand lift and cross merchandising execution could be very valuable for Family Dollar. There is a real chance that Family Dollar comes out of the pandemic in a structurally stronger position. If we recall the FDO problems that were dragging on the business over the years, they are: low sales productivity from poor/wrong merchandising in terms of customer value proposition, unhappy/unempowered store managers leading to high turnover, and shrink (out the back door so management problem). A little sales lift from the pandemic, cross merchandising with Dollar Tree $1 items (with Dollar Plus to come), and some store investment from H2 remodels, all of a sudden these problems are looking much better on the margin. As the CEO noted "our customer satisfaction scores are improving, and we are experiencing our lowest store manager turnover rates in many years." Much like the problems were, the successes becomes self-reinforcing. It goes from bad sales, unhappy manager, manager retention problem, shrink problem perpetuating even worse sales; to better store model, better sales, happier store manager, lower manager turnover, less shrink perpetuating better sales and margins. A real turnaround of FDO is not in our numbers, and could add an extra $2-$3 in earnings power if executed, the probability of which is much higher than 2 years ago.
With Dollar Plus following the cadence we expect, we think TAIL earnings per share is headed north of $10.00. If we’re right we see upside to $150 over 6-12 months and $200+ over 2-3 years. DLTR is historically not a great performer in Macro Quad2, but does very well in Quad4 on a relative and absolute basis. Macro is aligning long side at the same time with think fundamentals and catalysts start to look better in 2H21.
