In investing, sometimes even the best stocks get beaten down by the market. This is because no matter how great the underlying business of a stock may be, there are always challenges that come and go. The defining question of whether a stock is worth your investment is as follows: Do I believe this business will remain fundamentally sound moving forward?
Down 16% so far in 2023, shares of Dollar Tree (DLTR -2.62%) have drastically lagged the market this year. What has derailed the business and stock as of late? And can it get back on track? Let’s dig into the company’s fundamentals and valuation to put these questions to rest.
NASDAQ: DLTR
Key Data Points
Pain should only be temporary
Owning and operating nearly 16,500 stores across the U.S. and Canada under the Dollar Tree and Family Dollar brands, Dollar Tree is a major discount retailer. Thanks to its vast presence of stores, the company currently sports a roughly $27 billion market capitalization.
| Metric | Q2 2022 | Q2 2023 |
|---|---|---|
| Same-store sales growth rate (YOY) | 4.9% | 6.9% |
| Total store count | 16,231 | 16,476 |
| Net margin | 5.3% | 2.7% |
Data source: Dollar Tree.
In the fiscal second quarter concluded July 29, Dollar Tree’s consolidated net sales rose by 8.2% year over year to $7.3 billion. Since inflation continued to pressure household budgets for the quarter, more customers turned to the retailer to stretch their budgets further. This led to higher traffic to Dollar Tree’s stores during the quarter. Coupled with a slight increase in average ticket, that explains the company’s healthy same-store sales growth for the quarter. The final factor that pushed net sales higher was the company’s growing store count as it works to further expand its presence.
Dollar Tree’s non-GAAP (adjusted) diluted earnings per share (EPS) plunged by 43.1% over the year-ago period to $0.91 in the fiscal second quarter. Due to higher-than-usual shrink (e.g., the difference between expected inventory and actual inventory) and faster growth in the cost of sales and selling, general and administrative expenses categories, the company’s net margin significantly contracted during the quarter. The company’s share repurchase program and resulting decline in the share count couldn’t completely offset reduced profitability. This is why adjusted diluted EPS fell sharply while consolidated net sales grew for the quarter.
The good news is that even with high inventory levels and elevated expenses, Dollar Tree’s management team expects to deliver $10 in adjusted diluted EPS by its fiscal year 2026. That is because as inventory levels and expenses revert to more normal levels, margins should recover. Analysts agree with this forecast, which is why they predict that Dollar Tree’s adjusted diluted EPS will rise by 19.7% annually over the next five years. Put into context, this is better than the discount stores industry average earnings growth consensus of 8.6%.
Image source: Getty Images.
Dollar Tree has the resources necessary for a turnaround
Dollar Tree isn’t just depending on an economic recovery to stage its comeback: For one, the company has room to continue opening hundreds more stores each fiscal year to drive topline growth. Secondly, Dollar Tree’s roll out of more expensive $3 to $5-plus merchandise should both lead to increased interest from customers and result in a more attractive sales mix.
Finally, the company’s current financial state could help it to make the investments necessary to grow. This is because Dollar Tree is expected to generate $2.7 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA) for its current fiscal year ending in January. Compared to the $3.2 billion net debt balance that analysts are expecting this fiscal year, that is a manageable net debt to EBITDA ratio of 1.2.
An intriguing stock at the current valuation
Dollar Tree’s underwhelming stock performance looks to have opened a buying opportunity for investors. The stock’s forward price-to-earnings (P/E) ratio of 16.6 is well under the discount stores industry average forward P/E ratio of 23.3. Considering that Dollar Tree’s growth prospects remain superior to its industry peers, this makes the stock a buy at the current $118 share price for investors who concern themselves with growth and value.
