Is Dollar Tree Inc.'s Stock a Buy?

Dollar Tree's stock has slipped recently, but that could create a long-term buying opportunity for investors.

Sep 5, 2014 at 1:15PM

The economic recovery in the U.S. has been good for the dollar stores as consumers sought to stretch their wallets as far as possible, and none has benefited more than Dollar Tree (NASDAQ:DLTR). But because these tend to be low-margin businesses, rising fuel and freight costs could upset the apple cart, causing them to turn to losses.

DLTR Chart

DLTR data by YCharts.

While there's no guarantee that a stock will rise or fall and despite these potential problems, I explain below why I think Dollar Tree is still a stock retail investors want to own.

More profitable than its peers
Even though the deep discount variety store is the smallest of the publicly traded group, Dollar Tree still turns $0.12 of every dollar it generates into operating profits. Dollar General (NYSE:DG) converts less than a dime, and Family Dollar (NYSE:FDO) does just a little more than a nickel. 

Its flat-pricing focus has served it well as the everything-is-a-dollar format allows consumers to consistently budget expenses. It's always been about how much value it can offer for the $1 price point at a margin it's willing to accept, with customers knowing going in what their basket is going to cost. That's translated into consistent profits for the retailer: It has grown per-share earnings at a rate of 18% annually for the past 10 years, far outpacing either of its competitors.

Screen Shot

Data: Morningstar.

More opportunities for growth
Even though it is the smallest of the three publicly traded dollar store chains, with just 5,166 stores across 48 states and five Canadian provinces, that means Dollar Tree hasn't saturated the market yet.

Dollar General, for example, is more than twice as large, with 11,338 stores in 40 states, and if it were successful in acquiring Family Dollar, something it seems committed to as it just upped the ante by raising its already superior bid to $9.1 billion and providing a bunch of sweeteners to management (such as large breakup fees and antitrust reassurances), it would increase its footprint by another 8,200 stores in 46 states.

Images

Like money growing on trees.

Yet Dollar Tree believes the market can easily support 25% more Dollar Tree stores than currently exist here in the U.S., and it plans on building out its Canadian operations to at least 1,000 stores, some five times larger than the current 196-store footprint it ended the quarter with. Add in its growing Deal$concept, a store with prices above the $1 threshold, and there are many paths to continued growth.

Solid value in discounting
Certainly on several measures, Dollar Tree looks expensive. It trades at nearly 20 times earnings, and its enterprise value goes for a pricey 20 times free cash flow. Dollar General, though, is even more richly valued, also going for 20 times earnings but with an enterprise value trading at 28 times free cash flow. Family Dollar is simply burning cash.

Yet if we measure Dollar Tree's enterprise value to its EBITDA over the past 12 months, it's a more reasonable 9.6, whereas Dollar General is at 10.8, and Family Dollar a lofty 12 value.

For investors with a long-term view, Dollar Tree presents a great value in dollar store retailing. Even if it's not successful in nabbing Family Dollar, having been the one that set the wheels for the bidding war in motion, it remains the best-positioned, most profitable deep-discounting variety store on the market and ought to be worth holding onto well into the future.  

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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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