Dollar Tree (DLTR 0.77%) has been testing higher price points on merchandise in its stores for several years now, but runaway inflation, a tight labor market, and continued disruptions in the supply chain have the retailer broadly increasing prices. 

Maybe we ought to call it the Dollar-Fifty Tree from now on, because consumers may be hard-pressed to find anything costing a dollar on its shelves anymore.

Person holding dollar bills and giving a thumbs-up.

Image source: Getty Images.

The rising cost of low prices

So-called dollar stores have been that in name only for years, and Dollar Tree was long the only pure-play retailer in the space. A bruising proxy battle with hedge fund Starboard Value three years ago, however, forced the company to abandon the concept and begin testing higher price points in its stores.

It wasn't an across-the-board increase in prices, but rather a special section in its stores called Dollar Tree Plus that allowed it to charge higher selling prices. That's now spreading more broadly throughout the store as they creep up to $1.25 or $1.50, maybe more.

You're still not going to find really expensive goods in its stores like you will at Dollar General (NYSE: DG) or sister chain Family Dollar, which routinely stock items costing as much as $10 or more (though most of the goods are still in the $1 ballpark). Instead, Dollar Tree is pushing the envelope ever so slightly to offset the higher costs it is experiencing.

Last quarter, Dollar Tree said rising shipping expenses were costing it between $1.50 and $1.60 per share in profits. For over 30 years, Dollar Tree has steadfastly maintained the $1 price point, but even it has to give in to that economic reality.

A path to greater profitability

The stock market certainly liked the news, sending the retailer's stock 15% higher, and for good reason. By raising prices only a little, it allows Dollar Tree to offer larger sizes and greater selection, which ought to increase store traffic, sales, and profits.

President and CEO Michael Witynski said in a statement, "We believe testing additional price points above $1 for Dollar Tree product will enable us over time to expand our assortments, introduce new products and meet more of our customers' everyday needs." 

Net sales in the second quarter rose just 1% to $6.3 billion, but profitability surged 12% to $1.23 per share. That might not seem so great coming off a pandemic year, but Dollar Tree was one of those retailers that was deemed essential. Last year, its sales were up 9% for the period, meaning its earnings performance this time around was 62% greater than for the same quarter in 2019.

Even so, the supply chain issues hurt margins and the stock tumbled 12% after the company released the earnings report.

More options to spend more money are coming

Dollar Tree has been in turnaround mode for some time due to its acquisition of the ailing Family Dollar chain, but the profit picture had been steadily improving. Now it will be expanding the number of higher-priced stores it operates.

The retailer is on track to have 500 Dollar Tree Plus stores open by the end of the fiscal year and expects to have another 1,500 locations opened by the end of next year. By 2024, it aims to have 5,000 Dollar Tree Plus stores.

It also currently has 105 combo stores, or joint Dollar Tree-Family Dollar stores under one roof, and expects to add 400 more in fiscal 2022, with the potential for up to 3,000 over the next few years. The combo store's creation was a way to subtly introduce higher prices into the dollar store without really raising prices.

Witynski said the Dollar Tree banner wouldn't be immune, either, noting, "Our brand promise is that customers get great value for what they spend at Dollar Tree. We will continue to be fiercely protective of that promise, regardless of the price point, whether it is $1.00, $1.25, $1.50."

Still a big deal

With almost 16,000 stores and perhaps thousands more coming, Dollar Tree will continue to battle Dollar General for the title of biggest deep discounter by store count (its rival has over 17,000 stores), even if the discounts won't go quite as deep as they used to. 

Still, it was a necessary change for Dollar Tree, and it should reward investors in the quarters to come.