Dollar Tree (NASDAQ:DLTR) recently touched a closing low of $65.57. However, with a broad market rally, DLTR stock has quickly moved higher by 19.2% and currently trades at $78.14. I believe that upside can sustain for the stock in the foreseeable future.
I want to mention at the onset that the coronavirus has impacted multiple industries, but Dollar Tree seems relatively immune. This is the first reason to be bullish on the stock. To back my point, Dollar Tree recently announced the hiring of 25,000 part-time associates to meet the rising demand to cater to the rising demand. Further, the company also is offering its hourly-paid store and distribution center associates with a wage premium.
The reason is clear: The Company’s product offering falls under “essentials.” With the spread of COVID-19 and the lockdown, the demand is likely to remain strong.
Talking about the severity of the coronavirus driven economic slump, a record 3.3 million Americans filed for unemployment benefit. The unemployment rate is expected to increase to 13% by May 2020.
In this scenario, Dollar Tree stands to benefit as a “budget retailer.” The demand for the company’s low price everyday products will continue to be strong in the coming quarters. Households will look for cheaper essentials with relatively lower disposable income.
On the flip-side, the lockdown due to the coronavirus can translate into temporary store closures in certain districts. Further, the company’s highest sales are during Christmas and Easter. I believe that Easter sales can be impacted in the current year. However, pent-up demand can boost sales in Christmas later in FY2020.
The Valuation and Fundamentals Perspective
For the current financial year, analyst estimates point to an eps of $5.03. At a current stock price, Dollar Tree is trading at a price-to-earnings-ratio of about 15.5. Its earnings are expected to grow at a CAGR of 10.6% over the next five years. Therefore, valuation does not look stretched.
Recently, Telsey Advisory Group increased the company’s rating to “outperform” with a target price of $92. The mean target price from 22 analysts is also at $90.5. Even if I assume a target price of $90, there is potential for 15.2% upside from current levels.
Another factor that makes Dollar Tree attractive in uncertain times is the company’s improving balance sheet. In the last 12-months, the company has reduced total debt by $493 million.
The company also had a robust operating cash flow of $1.9 billion for the financial year ended February 2020. Even if the OCF remains at the same level for the current year, Dollar Tree is positioned to deleverage or increase the total cash buffer.
Dollar Tree is also positioned for growth in new stores, store expansion and relocation initiatives. In the last few years, the company’s growth has been from new store openings (besides recently remodeled stores) and that will continue even with the economic headwinds. Importantly, the expansion will be through internal cash flows rather than leveraging.
My Concluding Views on DLTR Stock
Dollar Tree has been in a phase of change with the growth of H2 format stores. The store has improved merchandise offerings that include Dollar Tree $1.00 merchandise sections. In addition, there are freezer and cooler doors, throughout the store.
The remodeled stores have boosted comparable store sales growth. Comparable store sales growth will continue to witness improvements as more stores are formatted to H2 in the next 12-24 months. New stores in H2 format will also be established besides remodeling of existing stores. This will help in accelerating growth.
Overall, DLTR stock is attractive from a valuation perspective and also from a fundamental perspective. Further, there is earnings growth visibility in the coming years and the correction provides a good opportunity to accumulate the stock.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
