For the quarter, comparable store sales (comps) increased 2.5%, with both banners (Family Dollar and Dollar Tree) reporting comp growth of more than 2%. As shown below, that’s a slight improvement from the consolidated comps we saw in the first two quarters of fiscal 2019.
But the two-year stacked comps tell a bit of a different story. The chart below shows that there has been a continued deceleration in the growth rate for Dollar Tree, as well as a lack of improvement at Family Dollar. For the company’s flagship banner, the two-year stacked comp has fallen from +7.4% to +5.2% over the past year. And at Family Dollar, despite the significant time and energy focused on trying to turn around the business, two-year stacked comps remain stubbornly around +2% (note that this metric is inclusive of the tailwind from the renovated H2 stores, as well as the benefit received from closing hundreds of underperforming locations).
In addition to relatively tepid revenue growth – due to the combination of low single-digit comps and immaterial net unit increases – the company is facing material headwinds down the income statement. For the company as a whole, year-to-date gross margins and operating margins have contracted 90 basis points and 140 basis points. In terms of operating margins, that reflects a 50 basis point decline at Dollar Tree (to 12.2%) and a 230 basis point decline at Family Dollar (to 1.9%). To put the Family Dollar results in context, the banner is on pace to earn somewhere around $200 million in operating income this year – a small fraction of the $9.2 billion paid to acquire the business back in 2015. Clearly, the results that we are currently seeing from the business are not living up to the expectations management had when they originally agreed to the deal.
We can see the impact of margin contraction at both banners and mix shift to the Family Dollar business by looking at the consolidated margins for Dollar Tree. As shown below, 2019 operating margins are at roughly half of the level that the company reported prior to the Family Dollar deal.
The company continues to reinvest a lot of capital back into the business, primarily on the Family Dollar turnaround. Capital expenditures in 2019 are expected to be $1 billion, which is about 20% more than it spent in 2018 (and nearly 60% above depreciation and amortization expense). To me, it appears likely that this pace of spending will not slow anytime soon. As CEO Gary Philbin noted on the third quarter conference call, “By the time we finish the next 1,000 [remodels in fiscal 2020], 40% of our fleet will be less than five years old”. Even at that point, there will still be another 4,700 locations that may need work, which would take five years at the current pace (on top of the ongoing renovations that are part of running a retail business). From my view, it looks like we’re still in the early innings of the Family Dollar turnaround efforts.
Despite management’s continued optimism, market participants have their doubts. Dollar Tree, which consistently traded at parity or even a premium to Dollar General (DG, Financial) in the years before the Family Dollar deal, now trades at a big discount.
I continue to believe that the Dollar Tree banner alone is worth more than $80 per share. Said differently, the market is putting little to no value on Family Dollar, which provides some upside optionality if the turnaround is successful (I believe management will remain unwilling to divest Family Dollar, even if the results continue to disappoint). My concern is that the efforts to turn Family Dollar will continue to produce lackluster results – and that the requisite focus on that banner may lead to some degradation in the results at the Dollar Tree banner (I have some concerns we’re already starting to see that happen). While I’m intrigued by the significant decline in the stock price following the third quarter results, I will remain on the sidelines for now.
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