I feel like I’m the only person who looked at Dollar Tree (DLTR) and Dollar General (DG) fight like unhappy siblings over who would get the “opportunity” to buy out the flailing dollar store operation known as Family Dollar (FDO).
I personally think this was all a big prank by Dollar General to get DLTR to pay far, far more for FDO than any sane person would. I want to show you how the numbers play out and then how this mess is going to resolve.
Dollar Tree is 75% larger in market cap than FDO, and yet has half of the employee base. Despite generating 17% less in sales it has almost double the net income.
Specifically, over the trailing 12 months (TTM) FDO produced sales of $10.5 billion, $369 million in operating income, and bottom line net income of $245 million (margins of 2.4%). However, it had a dismal cash flow situation, coming in with $469 million of negative free cash flow.
These numbers are not exactly stellar.
Meanwhile, over the TTM period, Dollar Tree produced $8.8 billion in sales, whereas operating income came in at $1. billion, leading to net income of $529 million (margins of 6%). In stark contrast to FDO, DLTR stock has $540 million in free cash flow over the trailing 12 months.
So why does DTLR, which I have always felt was the hands-down superior operation in the entire dollar store sector, need to buy a flea-bitten operation like FDO?
Organic growth has slowed quite a bit, which I find concerning because the Labor Force Participation Rate is at a 40-year low, meaning there are more people permanently out of work since Jimmy Carter was in the White House. I would think that would translate to strong growth for DLTR stock, but that’s not been the case. It’s possible that people are migrating back to grocery stores, or that the areas where Dollar Tree operates are just simply saturated.
My thought is that DLTR saw FDO and saw a way to turn that ship around. Traditionally, one might expect a limping operation that could show efficiency improvements to be purchased by private equity. The PE shop would wring out the inefficiencies, restore it to produce high cash flow, then spin it back off to the public.
Instead, it seems like Dollar Tree is going to take this route. Certainly the fact that the company’s margins and other efficiencies have always been excellent shows that management knows how to run a dollar store operation. Why leave it to PE when they have the expertise themselves?
One look at FDO financials tells you that there are many issues to be addressed, and if – if – DLTR management can whip this operation into shape, then it may just juice growth.
The combined businesses have TTM sales of $19.2, operating income of $1.4 billion, and net income of $780 million. However, this bugger now trades at a price-to-earnings ratio of 25. I don’t see organic EPS growth greater than 14%. That’s a price/earnings-to-growth ratio of 1.75 and that is too expensive for my taste.
I think DLTR stock is not going to advance all that much until the market gets a signal that integration and turnaround is going strong. To that end, I would either exit the stock and move on, or hold it and repeatedly sell covered calls (or naked puts), generating a few hundred bucks per month in income.
By the way, I’m not crazy about Dollar General either at its current valuation. Although it has TTM sales of $19.4 billion, $1.8 billion in operating profit, net income of $1.1 billion, and free cash flow of $1.3 billion, it comes in at 22x earnings. It also is growing earnings per share at 14%, so I consider that too expensive also.
As of this writing, Lawrence Meyers does not hold a position in any of the aforementioned securities.
