For fans of discount stores, Dollar Tree (DLTR) shares have risen from their 52-week low of $50.14 a year ago to stand at their 52-week high of $91 today. The rise has been almost unhindered, proving there is an exception to the rule that says nothing goes up in a straight line (nearly).
Looking at the business model, the environment they operate in, and the economic climate, it’s not hard to see why the company has performed so well as a business and as an investment. With a strategy that closes loss-making stores early and replaces them with stores that have better business potential, the company now own over 4,350 stores across 48 states under brands such as Dollar Tree (DLTR), Dollar Giant and Dollar Bills. Its flexibility and low level of debt have helped it cut costs, increase margins and positively surprise the market with its earnings in each of the last four quarters.
In the fourth quarter of 2011, the company reported comparable store sales had increased by 7.3%, while total sales grew by 12.8%. Earnings per share grew by 24% to a record $1.60 for the quarter, helped by the increased sales and an aggressive share repurchase scheme.
For the year, earnings per share came in at $4.03, an increase of 30% over the previous year although 2010 suffered by $0.13 per share due to a single non-recurring charge. Allowing for this, earnings per share increased by 25%.
The company bought back 3.5 million of its shares in the fourth quarter at a cost of $300 million. This in some part explains the decrease in cash and investments from $486 million a year earlier to $288 million at the end of 2011.
For 2012, Dollar Tree is forecasting earnings per share in the range of $4.65 to $4.90. This is a further increase of 15% to 22% on the year, and assumes no further share repurchases. If the company actions a similar repurchase scheme, then earnings per share should come in around $0.15 to $0.20 per share better than guidance.
Also helping the company is a strong handle on costs, which decreased by 30 basis points through the fourth quarter. This helped operating margin to stretch out to 15.5%.
With double the number of stores under its wings, Dollar General (DG) is another discount store that sells under the "all for a dollar" headline. It operates nearly 10,000 stores, mostly in the mid and southern states, but can’t match the margins produced by Dollar Tree. Its operating margin is around 10%, and though its quarterly earnings grew by 33.6%, it has a far worse debt position than Dollar Tree. With cash and equivalents of around $120 million, its debt of $2.74 billion looks a point for concern. Its operating cash flow of around $1 billion is sufficient to service this debt at the present time, but this level of debt could mean less flexibility moving forward. Dollar Tree, on the other hand, with so little borrowings under its belt, remains in a position to bid for prime location on new stores.
Those investors looking for a dividend from a discount store might be tempted to look at Family Dollar Stores (FDO). Trading at $55, shares yield 1.5%. It 7000 self-service discount stores are located in 45 states. Margins at Family Dollar are the lowest of these three discounters: at 7.6% operating margin and with a profit margin of 4.54%. It has less cash ($155 million) on its balance sheet than Dollar Tree, and with a debt position of $610 million its debt/equity ratio of 53 is approaching that of Dollar General.
Earnings per share growth at Family Dollar are a little below that at Dollar Tree. For its full year 2011, earnings per share increased by 15% from the previous year, and are expected to do the same through 2012. Dollar General’s earnings growth is expected to pick up a little this year, and increase by 16% from its 2011 result.
As shoppers are becoming increasingly better informed, the stigma of shopping at discount stores is disappearing. They are increasingly seen as stores of convenience for manufacturers, dumping near out of date or hard to sell stock, and consumers are realizing this and cashing in. This change in perception will continue to help discount stores grow at a faster pace than traditional high street stores for some time to come.
For my money the best of the bunch, Dollar Tree clearly has its store policy spot on. In the fourth quarter, it opened 21 new stores, while only having to close 5 under-performing premises. Its products, mostly priced at $1, cover all the household needs: from toys to candy for the kids, to foodstuffs, paper, plastic goods, and health and beauty for the family and mom. It caters to family purses that are becoming tighter as prices rise and wages stagnate.
Its cash and investment position of $288 million is larger than its debt of $265 million. With operating cash flow of $687 million, its financial position is very strong.
Expect Dollar Tree to continue with its winning business formula throughout 2012.
Looking at the 12-month chart, the shares have put on around 80%. Though the company pays no dividend, its policy of share repurchases has helped the share price marginally also. I see no reason why the shares should not continue to perform well, and expect them to break through $100 before their next results announcement. If these surprise on the upside again, then a price target of $110 is a reasonable level to think about taking profits. BUY.
About the author:I'm mostly interested in income investing using dividends, preferred stocks and other debt instruments, and pair trading.
I fundamentally analyze every business from the top down.
In my personal life, I have a strong Jewish faith and enjoy playing Scrabble and entrepreneurship.