Many retailers are reporting spikes in consumer spending this year linked to COVID-19, and Dollar tree (NASDAQ: DLTR) is no exception. Sales rose 9% in the first half of the year as shoppers reportedly make fewer trips but larger purchases at the value retailer. As a result, the stock rose around 40% from its March 2020 lows, even after falling after its second quarter report, as results were not as good as many investors had hoped. .
The effects of the pandemic have renewed demand for cheap, basic household items, even helping the ailing Family Dollar stores that Dollar Tree acquired in 2015. This is not a growth stock, however. Five years from now, I think investors would be happier investing elsewhere – here’s why.
Not really a high margin business
Dollar Tree had just under 15,500 stores as of August 1 with new locations opened under the Dollar Tree banner, bringing the division with Family Dollar stores to nearly 50/50.
Of the two banners, the namesake Dollar Tree is the more lucrative business. The operating profit margin was 9.4% at Dollar Tree in the first half of the year, compared to 5.4% for Family Dollar, for a total operating margin of 5.9% in the first half of the year. half of fiscal 2020. Since the acquisition of Family Dollar five years ago, the acquired stores have been a drag on the entire business – turning a retailer with a low operating margin percentage to teenagers in a single digit medium. Renaming Family Dollar to Dollar Tree stores and the renovations haven’t helped much, at least not permanently.
In comparison, Dollar Tree’s biggest competitor General dollar has done much better in terms of bottom line and its stock has been racing lately. Put simply, Dollar Tree has a lot of ground to catch up with after its questionable takeover of Family Dollar.
Plenty of liquidity counts for something
The economic lockdown to tackle the novel coronavirus has presented an existential threat to many retailers. Forced to close or substantially change their operations, many have been cash-strapped. Dollar Tree took $ 500 million from its revolving line of credit during the crisis to manage its cash flow, but its balance sheet is in good shape. At the end of last quarter, the value chain had $ 1.75 billion in cash and cash equivalents on the books. That’s over a quarter of operating expenses in cash, which puts this channel on a decent enough footing should another crisis strike.
However, the company also has significant liabilities with $ 4.02 billion in debt. While it certainly isn’t struggling, Dollar Tree isn’t the most agile of retailers either. With the best growing days for the dollar store concept likely in the rearview mirror, this outfit aims to pull those profit margins out of the trough they’ve been stuck in since Family Dollar entered the scene. And with the stock trading 14.9 times 12-month free cash flow, stocks look pretty valued right now. For investors looking for real added value in a brand that is also developing its profitability, I like Target.
The surge in sales due to COVID-19 will eventually subside, but demand for Dollar Tree’s cheap commodities is expected to remain strong. However, without a significant rebound in profit margins at Family Dollar, it’s hard to get excited about Dollar Tree’s five-year growth prospects. For investors looking to bet on the future of the retail world, there is better places to invest at present.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.