Avoid Dollar Tree, Inc. (DLTR) Stock and Its So-So Prospects

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The massive dollar-store chain Dollar Tree, Inc. (NASDAQ:DLTR) delivered earnings on Thursday, and for the most part, the numbers were solid … for its fiscal first quarter, anyway. However, the company guided lower for FY17, and that has DLTR stock off in Friday morning’s trade.

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Honestly, the guidance isn’t terrible in a bubble — Dollar Tree has guided lower before and still been an adequate holding — but DLTR shares a common problem with the rest of the market that should have investors shying away right now.

Dollar Tree Earnings

Sales is where we begin. DLTR saw a 4% increase to $5.29 billion, although that was only on the back of a 0.5% increase in comparable same-store sales. Now, it is the Dollar Tree brand itself that posted a respectable 2.5% increase in same-store comps. Stores still operating under the Family Dollar brand fell 1.2%.

This is significant, because branding does matter, as does management.

Over the past 10 years, whenever I publicly or privately compared the operating metrics for dollar stores, DLTR always came out on top in every category. Things like sales per square foot or sales per employee tell us things about how stores are managed. In theory, if Dollar Tree management is able to put its own synergies into place with Family Dollar, we would hope to see that chain’s same-store sales improve.

Gross profit only increased 4.7% to $1.63 billion with a 20-basis-point margin expansion. That’s not bad, but it’s far from robust growth. Worse, SG&A expenses increased 110 bps. Operating income increased 5%, as we might expect from the gross profit result to $440 million, and operating margins improved to 8.3% from 8.2%.

Dollar Tree didn’t repurchase too many shares this quarter, so the per-share profit number reported is pretty accurate. Backing out extraordinary items, EPS increased to 98 cents from 89 cents per share. That’s 10% improvement; not bad at all. It shows that Dollar Tree might not be a high-growth play, but it’s at least a stalwart company.

Speaking of extraordinary items, Dollar Tree earnings were affected by a one-time charge on impairment of receivables. For the Federal Trade Commission to bless the acquisition of Family Dollar, DLTR had to divest some stores to Dollar Express. However, Dollar Express is in liquidation, which is going to end up screwing Dollar Tree out of $51 million that it is owed.

DLTR has a massive footprint of 14,482 stores. Somehow, despite the tens of thousands of dollar stores across the country, Dollar Tree still found room to open 164 more while closing another 16.

The balance sheet looks pretty good. Cash sits at $1.16 billion. Debt is $6.298 billion, though it’s a bit expensive, with interest expense taking up about $300 million annually, so that’s about 5% interest. Yet free cash flow is $320 million for the last quarter alone, so kissing 25% of free cash flow goodbye to service debt isn’t unreasonable at this phase of the company’s history.

Bottom Line on DLTR Stock

Dollar Tree stock management cut the top end of its revenue forecast for the full year by about $80 million. It’s now targeting net income between $4.17 and $4.43, too. At the higher end of the range, Dollar Tree stock thus trades at about 17 times estimates.

That, however, is the problem I have with Dollar Tree stock.

As readers know, I don’t like overpaying for companies. If a company is growing net income at 15% or more, I’m willing to pay as much as a price/earnings-to-growth ratio of 2 for the stock (1 is typically considered to be “fairly valued”), based on certain factors.

However, for a mature company growing at 10%, that doesn’t have a massive net cash position, isn’t a free cash flow machine and doesn’t have a world-class brand name, I wouldn’t pay more than 10 times earnings.

Alas, that means for me to get involved in DLTR stock, it has to fall below $50.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he had no positions in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.


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