Many retailers are reporting spikes in consumer spending this year related to COVID-19, and Dollar Tree (DLTR 0.84%) is no exception. Sales are up 9% through the first half of the year as shoppers are reportedly making fewer trips but larger purchases at the value retailer. As a result, the stock is up some 40% from its March 2020 lows, even after a plunge following its second-quarter report as results weren't as good as many investors had hoped.
Effects from the pandemic have renewed demand for inexpensive basic household items, even helping the struggling Family Dollar stores that Dollar Tree acquired in 2015. This is no growth stock, though. Looking five years down the road, I think investors would be happier investing elsewhere -- here's why.
Not exactly a high-margin business
Dollar Tree had just shy of 15,500 stores as of Aug. 1 with new locations opened under the Dollar Tree banner bringing the split with Family Dollar stores close to 50/50.
Of the two banners, the namesake Dollar Tree is the more lucrative business. Operating profit margin was 9.4% at Dollar Tree during the first half of the year compared to 5.4% for Family Dollar, combining for 5.9% total operating margin through the first half of fiscal 2020. Since the takeover of Family Dollar five years ago, the acquired stores have been a drag on the business overall -- turning a retailer with a low teens percentage operating margin into a mid-single-digit one. Rebranding Family Dollar as Dollar Tree stores and renovations haven't helped much, at least not permanently.
By comparison, larger Dollar Tree competitor Dollar General has fared much better on the bottom line, and its stock has been off to the races as of late. Put simply, Dollar Tree has plenty of ground to make up after its dubious takeover of Family Dollar.
Ample liquidity counts for something
The economic lockdown to combat the novel coronavirus presented an existential threat to many retailers. Forced to close down or substantially alter operations, many have been in a cash crunch. Dollar Tree drew down $500 million from its revolving credit line during the crisis to manage its cash flows, but its balance sheet is in decent shape. At the end of the latest quarter, the value chain had $1.75 billion in cash and equivalents on the books. That's over one quarter's worth of cash operating expenses, putting this chain on decent enough footing if another crisis emerges.
However, the company has ample liabilities as well with $4.02 billion in debt. While it certainly isn't in trouble, Dollar Tree isn't the most nimble of retailers out there either. With the best days of growth for the dollar store concept likely in the rearview mirror, this outfit is all about getting those profit margins out of the trough they've been stuck in since Family Dollar entered the picture. And as the stock trades for 14.9 times trailing 12-month free cash flow, shares look fairly valued at this time. For investors looking for a real value in a retailer that is growing its profitability as well, I like Target.
Eventually the sales surge due to COVID-19 will wear off, but demand for Dollar Tree's inexpensive household basics should remain strong. However, without a big rebound in profit margins at Family Dollar, it's hard to get too excited about Dollar Tree's five-year growth prospects. For investors looking to bet on the future of the retail world, there are better places to invest right now.