When investors take a high-level view of Dollar Tree's (DLTR -1.23%) third-quarter 2022 earnings results, it's hard to complain about what was there to see. However, a closer look at some of the underlying trends suggests the results may not have been quite as strong as they appear.
Here's the good and the bad from the quarter and why investors need to pay close attention to Dollar Tree's customer base.
The big picture for Dollar Tree
Retailer Dollar Tree's overall sales rose 8.1% year over year in the third quarter of 2022 (ending Oct. 29) and its earnings were up 25%. From a same-store perspective, the company's sales increased 6.5%, led by the 8.6% advance at its Dollar Tree nameplate and a 4.1% improvement at Family Dollar. None of that is bad and, in fact, it all looks pretty darn positive.
Image source: Getty Images.
However, there are some interesting things going on beneath these top-level figures. For example, "Family Dollar delivered its strongest quarterly, same-store sales increase since 2020 and grew comparable traffic for the first time in 12 quarters." To be fair, Dollar Tree has been working to turn this struggling store concept around for some time. And the quarterly results suggest that things are starting to look better at this nameplate. Only one quarter does not make a trend, especially since negative store traffic was the norm for 12 quarters, or three years. Investors need to watch to make sure that Family Dollar's ability to attract customers doesn't falter again.
Amongthe the Dollar Tree branded stores, meanwhile, the same-store sales gain was "driven by a double-digit increase in average ticket, partially offset by a decline in traffic." Dollar Tree has materially changed its business approach over the last couple of years, going from selling all items at $1 to most items costing $1.25. That's a tiny change on an absolute basis but a huge change percentage-wise. And now it is starting to bring in products that cost even more, with prices going as high as $5 for some items. It is hardly shocking that consumers used to paying $1 would think twice about going back to Dollar Tree as its prices rise sharply, thus resulting in lower traffic numbers.
That same-store sales rose is good news, but when you look at the pricing changes taking place, the 8.6% increase seems modest compared to the price increases that have been implemented. Management is putting the most attractive number up front, as you would expect, but same-store sales may not be as important to the long-term future as foot traffic is today.
To be fair, the price hikes at Dollar Tree's namesake stores helped to increase margins. That's a good thing; gross margin across the entire company improved by 2.6 percentage points year over year through the first nine months of 2022. That's a sizable change. However, foot traffic was also down at both its nameplates over that three-quarter span. Given the budget-conscious positioning of the brands, you'd probably expect them to see more foot traffic while consumers are worried about an economic downturn.
Read between the lines on Dollar Tree
None of this is meant to suggest that Dollar Tree is doing the wrong things with its business. Inflation is high, and increasing prices is probably the right move. The problem is that consumers react to price increases in a pretty predictable way; they stop buying if they think they aren't getting enough value for their money. The traffic declines that the Dollar Tree branded stores are seeing suggest that the price hikes may not be resonating as well as they had in the past. And while Family Dollar's traffic inched up in Q3 2022, the longer trend is still in the decline camp. If you own or are looking at Dollar Tree, you need to look past the top-level picture and pay attention to consumer traffic. If you don't, you might end up getting blindsided.
