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Why Dollar Tree Should Prosper in Spite of Itself

By Will Healy – Jun 3, 2020 at 6:30AM

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Consumers need extreme discounters in a time of extreme unemployment.

During the pandemic, one might think Dollar Tree (DLTR -0.54%) stock would have performed quite well. Its grocery business kept it "essential," and low price points make it affordable to shoppers from any income level.

However, challenges with its online business and the ongoing struggle to absorb the Family Dollar acquisition have weighed on the stock in recent months. Still, despite these challenges, the millions of recently unemployed Americans offer investors plenty of reasons to give Dollar Tree a second look.

Dollar Tree takes discounting to a new level

Dollar Tree is a different kind of retail stock. Like its most direct competitors, Dollar General and Big Lots, Dollar Tree operates in what many describe as the discount sector of the discount sector. In other words, its offerings can make so-called "discount" retailers like Walmart appear expensive by comparison.

A dollar tree in a pot in a concrete room.

Image source: Getty Images.

With tens of millions of Americans left jobless as a result of the COVID-19 pandemic, any place described as an extreme discounter will likely see increased demand from cash-strapped consumers. Moreover, even in good times, an army of tight-fisted shoppers kept Dollar Tree in growth mode even as the average consumer became somewhat less price sensitive.

The struggles of Dollar Tree

Despite Dollar Tree's potential in the current environment, the company continues to face its share of struggles. For one, just as the COVID-19 pandemic shutdowns reached a fever pitch, the company made the curious decision to shut down online ordering. Though the company has since relaunched its e-commerce site, such a reversal may not inspire confidence in the company's management.

Also, the low prices the company offers force it to produce most of its products in China and other low-cost regions. Consequently, the tensions between the U.S. and China often weighed on Dollar Tree stock over the last two and a half years. Just as the company recovered to pre-trade war levels, tariff fears and slowing sales again persuaded investors to dump Dollar Tree stock.

DLTR Chart

Data by YCharts.

Even though the takeover occurred almost five years ago, Family Dollar has caused continuous problems for its parent company. In 2019, Family Dollar's recovery began to stall, and activist investor Starboard Value pressured management to divest the chain. This has led to store closures and the conversion of some locations into Dollar Tree stores. As late as the fourth quarter, same-store sales at Dollar Tree rose by 1.4% while they fell by 0.8% for Family Dollar.

The case for buying anyway

However, the pandemic may have given investors reason to overlook these problems. For one, in a reversal of fortune, Family Dollar seems to have rescued the company. In the first quarter, same-store sales for Family Dollar increased 15.5%, while they decreased 0.9% at Dollar Tree. A muted celebration around Easter hurt Dollar Tree, while Mother's Day and graduation helped Family Dollar.

Moreover, in April alone, non-farm payroll employment fell by 20.5 million. The layoffs continue, and early indications point to much higher unemployment numbers in May. Consequently, more families will struggle to pay their bills. The need for these families to keep expenses to the bare minimum means that many who previously avoided a Dollar Tree or Family Dollar store may begin to shop there.

These circumstances have not made Dollar Tree an expensive stock. A forward price-to-earnings ratio of 18.4 comes in below the stock's average five-year valuation. Also, Dollar Tree trades at a significant discount to rival Dollar General, which sells for about 23 times forward earnings estimates.

Dollar Tree can prosper in the aftermath of the pandemic, but ongoing tensions with China, not to mention the struggles at Family Dollar, will continue to weigh on the stock. With annual earnings growth expected in the high single digits over the next five years and a cheaper valuation, investors may find that Dollar Tree stock offers just the right bargain.

Will Healy has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Dollar Tree, Inc. Stock Quote
Dollar Tree, Inc.
$136.10 (-0.54%) $0.74
Walmart Stock Quote
$129.70 (-1.93%) $-2.55
Dollar General Corporation Stock Quote
Dollar General Corporation
$239.86 (0.16%) $0.39
Big Lots, Inc. Stock Quote
Big Lots, Inc.
$15.61 (-4.29%) $0.70

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