Dollar Tree Inc. (DLTR, Financial) reported results for the second quarter of fiscal 2019 on Thursday. I’ve written a few articles about the company over the past year, so an update seems worthwhile.
For the quarter, comparable store sales increased 2.4%, with both banners (Family Dollar and Dollar Tree) reporting comparable growth (with the growth for Dollar Tree driven by a combination of ticket and traffic). That’s similar to the consolidated results in each of the past two quarters, with improvement at Family Dollar offset by a slight deceleration for the Dollar Tree banner.
As shown below, the two-year stacked comps for the banners have been trending in opposite directions: Dollar Tree has reported lower growth in each of the past four quarters, while the two-year stack at Family Dollar in the second quarter was as strong as its been in the past year and a half (and up 160 basis points sequentially).
It’s worth noting that the growth in Family Dollar comps was driven by ticket (traffic was flat). In addition, gross margins for the Family Dollar banner have compressed by 240 basis points year to date (by comparison, Dollar General (DG, Financial) just reported a slight increase in gross margins). While Family Dollar management might argue this is temporary, the results suggest otherwise: gross margins are roughly 300 basis points below where they were two to three years ago. Personally, I’d argue that if the path to slightly higher comps requires material degradation in margins, it may not be worthwhile. And that’s flowing through the income statement: Year to date, Family Dollar’s operating margins have contracted by 350 basis points (in the first half of the year, operating profits for the banner fell by more than 50%). Again, I bet management would argue this is a temporary reset as they turn the ship and get moving back in the right direction. We’ll see in a few years whether that was accurate.
Despite these concerns, management shows no signs of slowing down. During the quarter, the company made changes at more than 800 Family Dollar locations (closed 296 and renovated 542 to the H2 format; as noted on the call, the retailer continues to see low double-digit lifts from the renovations, largely from traffic). The management team currently plans on completing an additional 1,150 renovations in the back half of the year. To put that in context, Family Dollar had 7,800 locations at the end of the quarter - meaning it will renovate or close about 25% of the base throughout the course of 2019.
Read more here:
- Why Growth May Not Lead to Investment Success
- The Importance of Proper Incentives
- A Stellar Quarter From Target
The result for the two banners over the past year was a 7% increase in selling square footage and Dollar Tree and a 5% reduction at Family Dollar, for a net increase of 1%. As a result, revenues increased by 4% in the quarter and year to date, compared to an 8% increase at Dollar General.
Consolidated gross profit contracted 120 basis points and selling, general and administrative expenses increased 60 basis points, resulting in material operating margin compression. As a result, operating income declined significantly, with adjusted earnings per share down 19% year to date. This is a material divergence from what we’ve seen from its retail peers.
Note that this is inclusive of “discrete costs” related to the company’s store support center consolidation and the acceleration of store optimization initiatives, including renovations, re-banners and store closures. Even adjusted for these costs, we’re still looking at a roughly 10% year-over-year decline in operating income.
Conclusion
Based on management’s commentary on the past few conference calls, it’s clear they are committed to the Family Dollar turnaround. And while the comps in the most recent quarter were somewhat encouraging, the reality is the financials (in terms of profitability) are struggling. I said six months ago that there’s a lot of work to be done. In my opinion, nothing has changed.
The Dollar Tree banner is worth roughly $20 billion on its own. The problem is Family Dollar, which the company paid $9 billion for a few years ago, is on pace to generate a few hundred million dollars in 2019 operating income. In my opinion, the value of that asset is not commensurate with the amount of attention and financial resources it is currently consuming (note that capital expenditures have increased by nearly 30% year to date).
Previously, I said I would consider buying the stock if Mr. Market became more pessimistic and pushed it to a level where I felt like I was getting the Family Dollar business for free. Now, I’m starting to question if that is the most appropriate course of action if you’re a long-term investor. Said differently, I don’t think this is as good of a business with the inclusion of Family Dollar. For that reason, I still don’t plan on buying the stock at this time.
Disclosure: None.
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