Investors reacted harshly to the latest earnings update from Dollar Tree (DLTR 0.09%). The retailer warned about rising profit pressures as consumers pull back on spending and as costs continue to rise. These comments contributed to a drop in Dollar Tree's stock price immediately following the late May earnings report.
But customer traffic trends were a major bright spot in the operating update, for both the Dollar Tree and Family Dollar brands. Let's take a closer look at the latest results -- and why the positive-looking traffic metric could propel the business higher in 2023 and beyond.
Getting to growth
Dollar Tree said in late May that revenue for the first quarter, ended April 30, rose while profitability declined in early 2023. Net sales reached $7.3 billion, up from $6.9 billion in the year-ago quarter. However, net income totaled $299 million, down from $536 million a year ago.
It has now been over a year since Dollar Tree raised its base price point level on merchandise to $1.25 from $1, and that strategy shift is starting to pay off. The boost helped increase average spending levels in Q1 but didn't convince shoppers to frequent rival stores. Instead, customer traffic was up 6% at Dollar Tree and rose 4% at Family Dollar.
Traffic levels declined for most of fiscal 2022, meaning the rebound could mark an important turning point on growth. "We continue to gain market share," CEO Rick Dreiling said in a conference call with investors, "and our traffic and unit volume growth are driving strong top-line momentum."
The bad news
That good news was overshadowed somewhat by Dollar Tree's gathering financial pressures. Management said a tilt toward lower-margin consumable products reduced profitability this past quarter, and so did elevated levels of shrinkage, which includes losses related to shoplifting.
Overall, gross profit margin fell by 3 percentage points, and operating margin fell to 6% of sales from 11% of sales a year ago.
The short-term outlook isn't bright on the earnings front, either. Dollar Tree is excited about how its investments in consumables like frozen and refrigerated food are boosting customer traffic and market share even though growth in this area is pushing profitability lower.
Management is aiming to offset this pressure over time, in part by introducing higher-price-point merchandise. But margins in 2023 will likely be lower than investors had hoped to see.
Looking ahead
Dollar Tree has a good shot at expanding its earnings power over the next few years, and customer traffic gains in early 2023 are an encouraging first step in that process. But investors might still want to watch this stock from the sidelines for now.
Increasing demand pressures from slowing economic growth threaten to delay the retailer's earnings rebound, and shares don't seem especially cheap at a valuation of 1.1 times annual sales. You can purchase Costco Wholesale and Walmart stocks at a lower valuation, with fewer concerns about a recession seriously threatening your long-term returns.
Dollar Tree's market share gains in a tough selling environment make it a stock worth watching, but its profit struggles should keep most investors on the sidelines for now.
