Buying companies with a proven business model and holding them for the long haul is a recipe for success as an investor. This is because while the stocks of great businesses can fluctuate significantly in the short term, they tend to do well in the long run.
Discount store chain Dollar Tree (DLTR -0.57%) is an example of one business that has done incredibly well for shareholders. A $10,000 investment in the stock made 20 years ago would now be worth over $164,000. For context, that is more than double the $67,000 that the same investment made in the S&P 500 index 20 years ago would now be valued at with dividends reinvested.
Dollar Tree has clearly been a millionaire-maker stock in the past. But can this continue in the future? Let's dig into the retailer's fundamentals and valuation to answer this question.
Avenues of growth remain for the company
Dollar Tree owns both the Dollar Tree and Family Dollar brands. As of Jan. 28, the company had more than 16,300 stores across five Canadian provinces and all U.S. states except Alaska and Hawaii. Understanding the investment thesis for this retailer starts with solving this simple question: How did the company become a retail juggernaut with a $34 billion market capitalization?
Dollar Tree's formula for success can be boiled down to this simple fact: Virtually everyone appreciates a good value. Each day, the company's merchandise buyers leverage their buying power with brand name suppliers to scoop up products on the cheap to turn around and sell to its customers. These widely trusted suppliers include the likes of Procter & Gamble, PepsiCo, and The Hershey Company.
And as big as Dollar Tree's footprint is, the market appears to be supporting further growth in its store count. The company opened 464 new stores and relocated 120 stores, compared to just 205 stores that closed in its prior fiscal year (fiscal year 2022). This is what propelled Dollar Tree's consolidated net sales 7.6% higher to $28.3 billion in fiscal year 2022, which is respectable growth for a well-established company.
Looking forward, the rollout of higher-priced products should be an even bigger growth catalyst for the company. Chief executive officer Rick Dreiling pointed out that Dollar Tree added $3 and $5-plus merchandise to 1,800 stores in 2022. Dreiling anticipates that the company will add these price points and new products to another 1,800 stores in 2023.
This expansion in product offerings is expected to provide a boost to the company's foot traffic. That's why analysts are projecting that Dollar Tree's diluted earnings per share (EPS) could compound by 15.9% annually through the next five years. Putting this into perspective, that is a far superior growth forecast to the discount stores industry average annual earnings growth outlook of 5.9%.
Image source: Getty Images.
The business is financially sound
Dollar Tree also looks well-positioned to continue funding new store openings and product lineup expansions. This is because the retailer's net debt is projected to be approximately $2.8 billion for the fiscal year ending in January 2024.
Compared to the $2.9 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA) that analysts are predicting this fiscal year, the company's net debt-to-EBITDA ratio is manageable at 0.9. This means that without considering interest expenses and tax obligations, Dollar Tree could repay its debt in less than a year if it decided that was in the best interest of shareholders.
An attractive valuation
The defensive nature of Dollar Tree in a looming potential recession, coupled with its superb growth prospects, has led to shares rallying 10% so far in 2023. Yet, the stock still looks to be a deal. Dollar Tree's forward price-to-earnings (P/E) ratio of 19.6 is meaningfully less than the discount stores industry average forward P/E ratio of 22.6. This makes the stock a buy for growth investors with the patience to let it compound in the years ahead.
