Dollar Tree (DLTR -0.16%) is still growing, but its short-term earnings outlook is worsening. That was the big-picture takeaway from the retailer's late May earnings update that covered the selling period through late April. Yet there was more to this report than just those headline results.
Dollar Tree is seeing strong customer traffic, even as shoppers become more cautious in their spending patterns. And, while profitability trends are weakening, the pressure isn't unique to Dollar Tree. Let's take a closer look at whether the stock seems attractive following its first-quarter operating update.
Rising traffic
The best news from the Q1 report is that the value-focused retailer remains a popular destination for shoppers. Customer traffic gains were strong, hitting 6% in the Dollar Tree brand and 4% at Family Dollar. These wins helped overall comparable-store sales rise 5%. Although strong, this comp increase trailed Walmart's recent 7% increase.
Yet Dollar Tree's management team said they were happy with the customer traffic growth, which was partly sparked by new merchandising and pricing initiatives. "We are clearly gaining market share across the entire enterprise," CEO Rick Dreiling said in a press release.
The bad news
There was bad news in this report, too. Like its peers, Dollar Tree is noticing increased levels of shrink, which includes theft, and a tilt away from profitable consumer discretionary sales. These pressures combined with increased markdowns to push profitability lower. Gross profit margin fell by three percentage points to 31% of sales, and operating margin dropped to 6% of sales from 11% a year ago.
Executives said this slump was powered by wider issues in the retailing industry rather than any specific competitive struggles. Dreiling said: "We are not immune to the external pressures affecting all of retail, notably, the margin impact of elevated shrink and the product mix shift to consumables."
Looking ahead
Dollar Tree still expects to see solid sales growth in 2023, thanks to the combination of rising spending at existing stores and an expanding store footprint. The earnings picture darkened slightly, with per-share profit on track to land between $5.73 and $6.13. But most of those earnings will arrive in the second half of the year, so investors won't get much clarity about fiscal 2023's performance for several months.
That's no reason to avoid this stock, which is valued at 1.2 times annual sales. That's a premium compared to Walmart and Target, yet Dollar Tree has more potential to expand sales and annual earnings over the next few years, especially as it recently migrated its primary price point to $1.25 from $1.
Cautious investors might want to wait until deeper into the fiscal year for more concrete evidence that Dollar Tree can achieve the margin rebound that management is predicting in late 2023 and over the next several years. If you don't mind more risk, though, consider adding this growing retailer to your portfolio. Shoppers continue to frequent its stores, and that loyalty should serve the company well through whatever selling environment develops over the next few quarters.
