Management of discount retailer Dollar Tree (DLTR -0.57%) spent significant time during the company's fiscal third-quarter earnings conference call looking ahead to fiscal 2019, particularly in the areas of real estate investment and supply chain improvements. Shareholders are also likely eyeing 2019 since the current year has proved a disappointment in stock price movement relative to discount peers:
As I've recently discussed, further work remains in Dollar Tree's gradual and painstaking process of bringing Family Dollar segment sales and margins up to the benchmarks of the company's namesake Dollar Tree segment. Let's examine three major points made by CEO Gary Philbin during Dollar Tree's earnings call to understand tactical changes related to Family Dollar (as well as the broader business) that might yield a more remunerative fiscal 2019.
Faster renovation at Family Dollar
If you look at the more recent renovations, we're seeing higher [comparable sales], which gives us the confidence we're executing well. We're therefore going to be accelerating our store optimization program in 2019. As of now, we expect to renovate a minimum of 1,000 Family Dollar stores in fiscal 2019.
Dollar Tree initiated its renovation program for Family Dollar stores 18 months ago. The company originally planned to renovate 450 stores (out of a total of roughly 8,200) by the end of the current fiscal year. However, due to the quick success of remodels in boosting sales, management shifted resources this year, dialing back new Dollar Tree store openings from 350 to 325 and reducing new Family Dollar units from 300 to 230. Instead the company has accelerated fiscal 2018 Family Dollar renovations from the original goal of 450 to a new target of at least 500.
As CEO Philbin implies above, Dollar Tree will double the Family Dollar renovation pace in the coming fiscal year. In addition to cosmetic changes, store remodels feature an improved layout that focuses on high-demand consumables and also adds food coolers, which help generate higher traffic.
Philbin noted that the typical remodel takes approximately two weeks, and he indicated that the exercise would extend well beyond 2019. But evidence of immediately higher comps from newly renovated stores should prove positive for patient shareholders: A climbing sales level is the first step in bringing the Family Dollar segment's gross margin of roughly 25% in line with the Dollar Tree segment's considerably healthier gross margin of approximately 35%.
Improved integration efforts
As part of the integration process, we focus first on building a single infrastructure by implementing initiatives to establish a single foundation to drive performance across the organization and support the growth of both Dollar Tree and Family Dollar brands. ... We improved logistic and supply chain efficiencies, including testing and refining the approach and systems for combined distribution centers. Our first combined distribution center is in St. George, Utah, where we began servicing both brands in 2016.
Integrating Family Dollar stores into Dollar Tree's management and operational systems has taken a long time -- nearly three and a half years have elapsed since the July 2015 acquisition. During the earnings call, management affirmed that all corporate support functions for Family Dollar have finally shifted to Dollar Tree's corporate headquarters in Chesapeake, Virginia.
In discussing logistics improvements, Philbin pointed to the opening of the company's latest combined distribution center, in Warrensburg, Missouri. Currently this facility is primarily serving Dollar Tree capacity, due to the number of "rebanners" of underperforming Family Dollar stores to Dollar Tree units over the past few years. However, the CEO indicated that integrated distribution at Warrensburg and other facilities would soon shift to a more balanced supply. The sharing of distribution resources should provide another tailwind for Family Dollar's gross margin improvement.
Image source: Getty Images.
A strategy to contain tariff impacts in 2019
Because of our team's efforts, the expected impact on tariffs to fiscal 2018 will be minimal. As we've always said with visibility and due cost and with some amount of time, we're typically able to navigate and manage a business for ways to offset these costs. Our options [include] negotiating price concessions from vendors, changing product sizes, specifications, and evolving our product mix. ... Assuming the 10% Section 301 tariff rate will increase to 25% next year, Dollar Tree has already mitigated the potential impact of 2019 tariffs by 80% and Family Dollar by 50%.
Philbin discussed the specific steps Dollar Tree is taking to mitigate an expected increase in import tariffs from 10% to 25% next year. In addition to the examples provided above, Philbin mentioned efforts to obtain a "better cube" to reach the U.S. at more favorable landed costs. In other words, the company is working with vendors on the assortment and timing of container shipments, and even the method by which products are grouped and packed, to minimize tariffs at a granular level.
Investors should be aware of one additional tactic. Dollar Tree has increased its inventory to $3.7 billion, a 9% year-over-year bump and a 13% increase from the prior sequential quarter. One way to partially avoid an escalation in tariffs is to purchase and receive inventory before the tariffs take effect.
CFO Kevin Wampler stated on the call that Dollar Tree's inventory per selling square foot increased by 7% in the third quarter against the prior year. This amplification happened despite a 5% year-over-year expansion in selling square footage. Wampler remarked that the bulk-up in inventory "reflects the acceleration and [receipt of] certain import goods to minimize the impact of increased tariffs." We'll have more detail on practices to absorb tariff impacts next quarter, when Dollar Tree reveals its guidance for the fiscal 2019 year.
