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Consider Buying the Dollar Tree Dip


The pullback in the stock price today has this investor wondering if an attractive longer-term entry point has been created.

Dollar Tree (DLTR) was a name that didn't tickle my fancy ahead of earnings. Premium relative valuation on a company selling goods at a $1 in an increasingly competitive marketplace and a well-worn investment thesis were classic setups to a sell the news event come earnings, which is what went down. Underneath the hood, there were at least two negative fundamental aspects to Dollar Tree that were going unappreciated in the share price, as well as a nagging one.

Dollar Tree not-so-fun facts:
  • The sales mix is shifting toward the negative (selling lower margin items more frequently) by the company's own doing; its new, lower-margin food offerings in the assortment are turning quickly and eating up a bigger percentage of the sales pie, constraining gross margin potential. This is a fundamental shift in the business, something also seen at Family Dollar (FDO).
  • Moderating comparable store sales growth and higher occupancy costs is not a good combination for a retailer, or for the intelligent investor.
  • Elevated fuel prices will continue to be a headwind in 2012.
As it is for any good handicapper presented with new information, revisiting a favorable or unfavorable investment thesis is a needed exercise. As it pertains to Dollar Tree, the pullback in the stock price today has left me wondering if an attractive longer-term entry point has been created. Here is what I'm seeing upon close examination:

Comparable store sales and margins:

Wal-Mart (WMT) had a sour quarter on the gross margin line as it increased its investment in lower prices. (Insider secret about how this is done: The company saves money in one area of operations and applies it to offsetting the lower merchandise prices.) Dollar Tree not only trounced Wal-Mart's US same-store sales performance (7.3% versus 1.5%), but also managed to expand its gross margin 20 basis points year-over-year, even while its sales mix ran negative and its largest foe was sending shock waves throughout retail. Two words: no joke.
  • Comp growth accelerated sequentially.
  • Fourth-quarter comp increase was the first year-over-year improvement (rate wise) in two quarters.
One has to believe that with over $1.2 billion remaining on its share repurchase authorization after spending $600 million plus in 2011, Dollar Tree will be an opportunistic buyer of its stock in 2012. If we get stronger earnings power, which is a takeaway I have post-holiday quarter, and it is coupled with no share repurchases in the fiscal year guidance, the upside potential to the bottom becomes quite intriguing.

In the end, some form of space has to be made in the equities portion of the portfolio for a dollar store. The concept has so many macro and firm-specific tailwinds at its sails (can't believe I just used that language) that it would be a bore to list them all. However, a Dollar Tree has to be bought very carefully given the valuation and changes under way in the business; I tend to make calls on the stock around earnings season and then let them ride until the following earnings season.
No positions in stocks mentioned.
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