As each New Year comes ringing in, I consider adding or subtracting candidates for my own portfolio. I may add to existing names, or even short a company. This year, however, I’m rebalancing my retirement portfolio. Each week I’m examining a stock that I’ll consider adding to this long-term diversified portfolio. No shorting in a retirement portfolio for this investor!
Today’s candidate: Dollar Tree Stores (NASDAQ:DLTR).
I remember the mid-1990s, when one of these dollar stores was right down the street from where I lived. I decided to give it a try and load up on stuff to see if the quality was comparable to the grocery stores. If so, I might save a lot of money.
The quality was complete crap. The soap wasn’t soapy. The tomato sauce, however, was. The toilet paper felt more like sandpaper. I could go on, but you get the picture. I vowed to never set foot in a dollar store again.
But these stocks seemed to be doing well. I guess I was too snooty to shop there, but others weren’t.
Then one day in 2007, I decided to revisit a dollar store, and I chose Dollar Tree. I was blown away. Now it had name-brand merchandise. I mean, we’re talking actual Dove soap that was really soapy, not “Dova” that was like water mixed with glycerin. I became a believer.
Every time I ran the numbers on all the dollar stores, Dollar Tree always came out ahead, and it still does, on virtually every metric. Today, the company continues to fire on all cylinders. Even better, it’s enjoying the struggles of a weak economy, as people cut expenses and move into dollar stores from grocery stores.
Add in the fact that Dollar Tree carries actual groceries and produce, and Kroger (NYSE:KR) and Safeway (NYSE:SWY) have some serious competition.
Dollar Tree sits on $222 million in cash. For the longest time, it never carried any debt, but it has drawn down $250 million in cheap long-term debt to help with expansion and new initiatives.
The company has always generated gobs of free cash flow — $340 million in fiscal 2010 and $430 million in fiscal 2011. It has pumped out over $350 million in the trailing 12 months. Dollar Tree tosses a lot of that money at repurchasing stock, having bought back over a half billion dollars of it in the last 12 months, or about 5% of outstanding shares.
It continues to grow organically at around 15%, which on fiscal 2013 earnings of $2.82 gives it fair value of around $43. That price point is very significant. Ninety-Nine Cent Stores was taken private for $1.6 billion. Adjusting for the 21 price-earnings multiple at the time, the equivalent valuation for Dollar Tree would have been $9.7 billion — or about $43 per share.
So, the market is currently valuing Dollar Tree at less than the equivalent price paid for Ninety-Nine Cent Stores — which had metrics inferior to Dollar Tree’s.
The question is whether a company that’s 12% undervalued (at a minimum) and growing at 15% organically belongs in my retirement portfolio. I’d say the answer is YES. I need a solid growth play in there, and I know this company well. I’ll be adding sometime in the next two weeks.
I want to point out that competitor Dollar General (NYSE:DG) is a fine company, also growing at about the same clip and arguably even more undervalued. However, it also has $3 billion in debt, which is sapping the bottom line by $100 million annually in interest payments. Family Dollar (NYSE:FDO) is struggling with negative free cash flow of about $250 million in the trailing 12 months. It’s growing much slower at 11% and is overvalued at 14x estimates.
Lawrence Meyers does not presently own any securities mentioned, but plans to purchase Dollar Tree stock in the next two weeks.