Dollar Tree: A Growth Story?

07/07/2017 2:52 am EST

Focus: CONSUMER

Jack Adamo

Editor, Jack Adamo's Insiders Plus

I must admit that with the market so overvalued, I'm reluctant to buy anything, even at a reasonable price. Nevertheless, I am recommending Dollar Tree (DLTR), the largest chain in what is called the retail discount & variety sector, notes Jack Adamo, editor of Insiders Plus.

Unlike most other "dollar" stores, Dollar Tree sells every item in its store at the same $1 price. One might reasonably question how a store can make money that way, but the fact is that Dollar Tree does. It has grown same-store sales for 37 consecutive quarters and full-year earnings for the last year grew 9%.

That's not high growth, but it's darn good, especially considering most stock indices showed shrinking earnings in 2015 & 2016. So, while it isn't the sexiest stock you'll ever see, it certainly merits a closer look.

The shares are selling at 18-times GAAP earnings, or 17-times trailing earnings, excluding an impairment charge which I think will be recovered. That being the case, it's nice to buy something whose stock price is in line with its earnings.

The company took on a lot of debt to acquire Family Dollar Stores in 2014. However, operating cash flow is very strong at two times earnings. Free cash flow (that is, after capital expenditures) is 50% higher than earnings.

Moreover, management has used the cash wisely, paying off 10% of its debt last year. Dollar Tree pays no dividend yet. All its cash is going into debt reduction or upgrading its stores, especially those it acquired. That has been a bit of a drag on earnings.

However, upgrades are showing good results in the Dollar Tree stores and although the Family Dollar Stores brand will require more work, management shows the acumen to get it done.

In the meantime, we can expect debt to shrink significantly over the next few years, as free cash flow continues to be applied to paying it down.

The firm's full-year 2016 EPS rose 200% to $3.78, but Q1 2017 disappointed the market when earnings slid 13.3%. In response, the shares dropped 22% and are 34% off their all-time high.

The earnings slide would be alarming, were it not for a very good, very temporary, actual "one-time" item. The company took a $50.9 million impairment charge for bad debt due to an unusual circumstance.

Dollar Tree was required to sell 300 stores in certain markets before the FFTC would approve its acquisition of Family Dollar Stores in 2014. The stores were sold to a private-equity firm called Sycamore Partners. Sycamore sold the stores to another company and has refused to pay what it owes Dollar Tree.

Dollar Tree will take an additional impairment in Q2 for this matter, but the current earnings forecast has taken this into account. The company has instituted legal action against Sycamore (which has deep enough pockets), and from what I know of the case, I think Dollar Tree will win.

Of course, the courts are so unpredictable that you can never hang your hat on an expected outcome, but the odds look good to me, and there seems little downside risk to earnings, the loss having already been priced in.

Some Wall Street analysts are afraid that the current administration's plans to cut food stamp funding by 25% may hurt sales at Dollar Tree.

While that's possible, such cuts could drive more business to Dollar Tree, as things get tighter for low income families. As a result, things could go either way, or cancel each other out with little net effect.

Overall, Dollar Tree looks like a reasonable buy in an unreasonably priced market. Let's give this company a chance. DLTR is a buy up to $67.50.

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