On August 16, Dollar Tree (NASDAQ: DLTR) reported mixed Q2 results. Reported EPS of $0.51 was $0.04 ahead of the consensus estimates but a lower tax rate and interest expense added ~$0.03 of upside to the consensus estimates. However, despite the EPS beat, 2Q SSS growth of 4.5% was below the consensus estimates of 5.1%. While a 4.5% SSS growth is still healthy, but it showed a 350 bps deceleration on a 2-year stack, to 9.2%, the lowest since 4Q09 (8.8%), and is a cause of concern to the investors. Going into 2H12, SSS is expected to be up low to mid-single digits, but a possible shift of two days prior to Halloween and the possibility of consumer uncertainty around the upcoming election could hinder SSS.
Over the past four years, shares of Dollar Tree stocks have returned over 262% as a result of robust traffic trends. However, we believe the traffic is likely slow down in the coming quarters and SSS could slow below 4% as early as 4Q. Dollar General (NYSE: DG) seems to be focused on Dollar Tree’s key traffic driving categories and is providing a tough competition. Dollar General continues to add coolers (to drive traffic and ticket) and re-merchandise key categories. Some of the focus areas for Dollar General (greeting cards, stationary, arts & crafts, and $1 price point items) cause us concern that they could begin taking share from Dollar Tree. Dollar General has been expanding its offerings of two greeting cards for $1 and adding $1 stationery and arts & crafts supplies to draw in teachers, which represent a big customer segment for Dollar Tree. Dollar General also is planning to increase $1 seasonal goods by 28% this holiday season, up from 23% two years ago. Moreover, 59% of Dollar Tree stores are within three miles of a Dollar General. Further, it is estimated that 50% of frequent Dollar Tree shoppers also shop at Dollar General. Thus, there’s a substantial overlap in Dollar General and Dollar Tree customers, and even a market share loss of 1-2% would be enough to send Dollar Tree’s SSS into low single digits.
During the past several years, dollar store stocks including Dollar Tree, Dollar General and Family Dollar Stores (NYSE: FDO) have extensively outperformed the broader market. Along with Dollar Tree, both these companies have also seen a good year to date run up. The long term growth prospects for these dollar stores remain strong as the domestic middle class population is continuously getting squeezed by unemployment and stagnating wages. Dollar Tree’s is trading at the historically high valuation of 17x (well above its 5 year average) and at ~11% premium to Dollar General and Family Dollar. We believe there is a good possibility that 4Q SSS could slow to low-single digits given difficult comparisons (SSS was up 7.3% in 4Q11) and increased competition. Thus, we are concerned that the company’s multiple could contract significantly, if SSS start to slow to low single digits. Despite a 14% correction in the last two months, there is an additional scope for another 10% correction. Thus, long term investors looking to buy these stocks are advised to await a pullback before initiating a long position, and investors looking for short-medium term investment opportunities are recommended to remain on the sidelines and avoid this stock.
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