Dollar Tree (DLTR +0.16%) has offered enough bargains to grow into a leading company in its retail niche. It debuted in March 1995, coincidentally at the split-adjusted price of just over $1 per share. Trading at about $107 per share today, Dollar Tree stock may have become the store's best dollar-store bargain.
However, retail remains a competitive industry, leading to questions about whether the company can deliver for investors over the next year. Let's take a closer look at the company to see whether it could become a great buy.
The state of Dollar Tree's business
Dollar Tree is a retail stock competing in the ultra-discounting business. It operates more than 15,600 stores under the Dollar Tree and Family Dollar names across the U.S. and Canada. Since it is a discounter among discounters, stores such as Dollar General (DG 0.54%) and Big Lots (BIG +0.00%) are its most direct competition.
Image source: Getty Images.
Dollar Tree is well-positioned for the current economic climate. Due to the COVID-19-induced economic decline, demand for low-cost products has risen. But the company has shown it can also grow in good times. Net sales growth was being reported before the coronavirus pandemic dominated the news as many better-heeled consumers were looking for bargains then as well.
However, Dollar Tree's competition continues to intensify. Even Amazon has begun to offer items in Dollar Tree's price range. Also, the company's performance has lagged that of Dollar General and the S&P 500 index since it acquired the Family Dollar line of stores in July 2015.
Moreover, geopolitical forces have cheapened the company's value proposition. With increased government tariffs introduced over the past two years on products sourced from China, finding items to sell profitably for $1 has become more challenging.
To this end, it introduced a pilot program called Dollar Tree Plus!, which features items at $3 and $5 price points. Additionally, it has begun to address the problems associated with its Family Dollar stores. In 2019, it unveiled its H2 plan, which began the process of renovating Family Dollar's stores.
Financials point to massive growth, uncertainty
The investment in Family Dollar seems to have produced positive results. Since the pandemic began, this struggling subsidiary has now posted higher comparable sales growth than the Dollar Tree stores. Moreover, the increased need for discounts has helped boost profits. Consolidated net sales rose by almost 8% year over year, helping to take diluted earnings per share higher by 29%.
Dollar Tree stock rose by approximately 15% this year. Additionally, the stock sells for a forward P/E ratio of about 17. This forward multiple has changed little over the last two years. Uncertainty about future sales growth may explain the relative lack of investor reaction to the profit increase. The uncertainty could also be a result of the company declining to offer any forward guidance in its most recent earnings report. Moreover, at some point, investors know COVID-19 will fade, leading to a rise in employment. Even if net sales growth remains positive, higher incomes could dampen demand for low-cost goods.
Dollar Tree one year from now
Dollar Tree continues to register growth in good times and bad. Since discounting does not seem to go out of style, I think Dollar Tree's growth can continue.
However, its performance has lagged the S&P 500 in recent years, and investors have no reason to expect this to improve over the next year. With Amazon becoming a more direct peer, rising pressure on Dollar Tree's margins could limit profits. Furthermore, an economic recovery could reduce net sales growth during the year as more shoppers again turn to higher-priced items.
Dollar Tree will probably continue to deliver bargains to its customers. Nonetheless, investors looking for outsized stock gains in 2021 would probably earn higher returns elsewhere.
