Potential for Improvement Seems Already Priced Into Dollar Tree Stock

DLTR stock - Potential for Improvement Seems Already Priced Into Dollar Tree Stock

Source: Shutterstock

There are reasons for investors to be optimistic about Dollar Tree (NASDAQ:DLTR). While the company’s 2015 purchase of Family Dollar hasn’t quite worked out as expected, new plans to fix that unit, and new initiatives in the legacy business, suggest potential upside in DLTR stock.

The catch is that Dollar Tree stock seems already have priced in at least some of that success. Initial FY2020 (ending January 2021) EPS guidance suggests about a 17x forward EPS multiple. That’s in line with rival Dollar General (NYSE:DG) — but that guidance assumes results are going to get better starting in the second half of this year.

I’ve long preferred DG to DLTR stock, and at similar valuations, that’s still the case. Dollar General is a better operator. Dollar Tree still needs to get to that point — and even if it does, it doesn’t look any cheaper. As as result, I’d like to see Dollar Tree stock a lot cheaper before turning bullish.

Improvement On the Way for DLTR Stock

Dollar Tree clearly overpaid for Family Dollar. Plans to accelerate same-store sales growth at the chain haven’t quite worked out. Same-store sales for the Family Dollar banner rose just 0.1% in fiscal 2018, after a 0.4% increase the year before. In contrast, Dollar Tree stores grew comps 3.5% in FY17 and 3.3% last year.

Further highlighting the problems, Dollar Tree took a non-cash $2.7 billion goodwill impairment change on the Family Dollar acquisition in Q4. And it’s closing as many as 390 stores next year, assuming it can’t squeeze rent reductions from landlords. Another 200 stores are being rebranded as Dollar Tree locations.

In hindsight, the failed acquisition is bad news. But looking forward, the struggles at Family Dollar represent an opportunity. Any improvement in the chain — or benefits from the rebranding — can accelerate growth and boost Dollar Tree’s overall prospects.

The store closures should help margins. Existing stores are being moved to a new model, known internally as H2. Under the new model, merchandise offerings are improved, including $1 Dollar Tree-branded merchandising. Early tests have been hugely successful, per the Q4 release. The addition of alcohol sales and expanded freezers should help as well. Management expects a 1.5-point boost to comp store sales once the initiatives are fully in place. That’s a big number for a chain that has barely grown same-store sales at all of late.

Earnings Growth Should Help Dollar Tree Stock

It will take some time for the efforts to bear fruit. Management actually is guiding for operating income to decline year-over-year in the first half before an improvement in the second half. Full-year adjusted EPS is expected to slip, in part due to a higher tax rate.

But in fiscal 2020, Dollar Tree expects earnings growth to accelerate markedly, with initial guidance for a 14-18% EPS increase. That suggests something in the range of $6.20 per share — and a roughly 17x forward P/E multiple for DLTR stock.

Against mid-teens earnings per share growth, that figure seems cheap. And there are potentially levers to pull beyond remodeling and rebranding Family Dollar stores. Management is testing price points beyond the $1 figure, a suggestion made by activist Starboard Value. Starboard has had some big wins in recent years — among them Advance Auto Parts (NYSE:AAP) and Olive Garden owner Darden Restaurants (NYSE:DRI) — and DLTR could benefit from its expertise in targeting consumers.

Family Dollar’s multi-year disappointment suggests a revitalized business could have years of growth ahead of it. And Dollar Tree has managed to do well despite strength at Walmart (NYSE:WMT), which hasn’t always been the case.

There is good news here along with room for more good news. In that context, the 17x forward EPS multiple for DLTR stock might look cheap.

Is DG Still The Better Play?

That said, Dollar General stock trades at a roughly similar forward multiple. And it’s worth noting that there’s quite a bit of uncertainty to Dollar Tree’s FY20 guidance. The company is projecting a big uptick in comps from the H2 model and other initiatives. That uptick isn’t guaranteed – and neither is the 14-18% growth management sees coming next year.

In contrast, DG investors can pay roughly the same multiple for steadier, and probably more certain, performance, with a two-year growth rate that actually looks a bit stronger.

Admittedly, investor preferences might be different among the two stocks. Dollar Tree stock, given Starboard’s presence and the efforts at Family Dollar, likely has more upside in the best-case scenario. It also has higher risk.

From here, DG is the steadier, safer, and better bet. But others might see it differently – and Dollar Tree has enough options to prove me, and other DLTR stock skeptics, wrong.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2019/04/potential-improvement-seems-priced-dollar-tree-stock/.

©2021 InvestorPlace Media, LLC