Dollar Tree Inc. (DLTR, Financial) spiked on Tuesday after the New York Post reported that billionaire activist investor Carl Icahn (Trades, Portfolio) had built a sizeable stake in the discount retailer. Shares ended the day at $86.48, up nearly 7% from the previous close.
Dollar Tree has been struggling for a while, but its core business remains strong, with stable revenue growth, even when accounting for the 2014 acquisition of Family Dollar.
But uninspired management has held to a narrow strategy, while failing to invest sufficiently in its thousands of stores across the country. If Icahn can shake things up, it could mean considerable upside ahead for this stock.
Struggling dollar store
The past 12 months have been especially hard on Dollar Tree. Before the Icahn announcement, shares were down 11% over the 12-month period. The Tuesday spike has closed most of that gap, but not all. Rival Dollar General (DG, Financial) was up nearly 30% over the same period.
Part of the problem is high debt, the product of the 2014 acquisition of Family Dollar. Interestingly, Icahn was involved in the deal, having built a stake in Family Dollar and then pushed it to sell itself. Dollar Tree ended up paying $8.5 billion in cash and stock for Family Dollar, and Icahn walked away with a fat profit.
Now, as the debt burden makes it harder for the company to invest across its 15,000 locations while keeping prices at dollar-store levels, it looks like Icahn again sees an opportunity. Indeed, Dollar Tree’s core business is sound and it makes solid returns. But it could do a lot more, given the right inducement.
Agent of change
While one might accuse Icahn of being one of the architects of the Family Dollar deal that saddled Dollar Tree with debt and thus caused its current woes, that would be a somewhat reductive explanation. Rather, it is important to recognize that Dollar Tree has a good business but sleepy management. A push for strategic change could go a long way to shaking the company (and its stock price) out of its funk.
There are a couple things we see as easy strategic moves that could create significant positive change for Dollar Tree. First and foremost, the company should experiment with expanding its product offerings beyond the “$1 or less” category. Of course, this could cause brand damage if not executed correctly. But even a gentle nudge in the direction of more expensive products could increase margins substantially. It would be a balancing act, but we see it as eminently doable.
The other change we see as necessary involves its 15,000 stores, especially the Family Dollar stores. Currently, management is far too centralized and top-down. The result is a suite of products at each store that is not effectively, or at least ideally, targeted at the particular economy markets in which they operate. By giving store managers more control over inventory selection to focus on products that have exclusively regional demand, Dollar Tree could win over new customers and grow the sales with existing customers.
Verdict
The Icahn news has jolted the discount store market. While Dollar Tree jumped most, the whole industry was buoyed by the news the activist was involved in the sector once again. Dollar General finished Tuesday up 4%.
The question now is this: What does Icahn have planned?
If the aim is further consolidation, then the debt problems might only worsen for Dollar Tree and could even weigh on the strength of its core business. But if Icahn is getting in to push for changes in operations along the lines we have suggested, then the future might be bright indeed for Dollar Tree.
We will wait on the sideline for now. While it could mean losing a bit of upside, we see this as the prudent choice until Icahn’s intentions become clearer. Effective execution of a strategic shift could be a major engine of growth that could see far more upside over a slightly longer time horizon.
Disclosure: No positions.
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