Money has been growing on trees for the dollar store chain lately, but there still remain risks to keep an eye on.
Dollar Tree (DLTR 2.97%) stock is up more than 20% over the last three months. Although much of the gain can be attributed to acquisition activity, its latest quarterly earnings report shows why it's moved 35% higher from the lows hit in February: same store sales recorded their best gain in three years as customers continue to respond to the growing assortment of consumers products that offer a compelling value proposition.
But as strong as its results are (and have been), smart investors know to keep an eye out for speed bumps that could derail its progress. Here are three of the biggest concerns for the dollar store chain.
1. Fuel prices could rise.
While Dollar Tree is enjoying the benefits associated with falling gas prices, and could see even more gains in the future as their decline puts more money in its customers' pockets, any sort of reversal of that trend could hit the discounter's bottom line.
According to Dollar Tree's CFO, diesel fuel costs in the third quarter were down $0.13 from last year, which wasn't much different than what they forecast at the start of the year, so the benefit wasn't so pronounced. But come the fourth quarter it's expected to be a lot lower than a year ago and could benefit their bottom line. As the CFO noted, a $1 drop over the course of the full fiscal year could translate into a $0.10 per share gain for earnings.
Fuel prices have plunged and are expected to stay low, but another spike could always cause a shock to the system. Photo: Flickr via Richard Masoner
The one risk Dollar Tree highlights in its latest quarterly report is that of diesel fuel costs. It entered into fuel derivative contracts for about 20% of its domestic truckload needs through January 2015, and additional derivative contracts covering 40% of its needs through January 2016.
But if the lower prices don't materialize, the gains Dollar Tree forecast would disappear as well. But if prices do fall lower, and there's good reason to believe they will, Dollar Tree ends up paying more for its fuel than it otherwise would.
According to the U.S. Energy Information Administration, diesel fuel prices (including taxes) are expected to average $3.82 per gallon in 2014, $0.10 per gallon less than last year, or down 2.5%. In 2015, however, the agency is forecasting diesel fuel prices will fall to $3.38 per gallon, down 11.5%. Still, it's something investors need to be mindful of.
2. Port truckers strike could linger on.
Dollar Tree's gross margins shrank from 35% in the third quarter last year to 34.6% this year primarily because of increased freight costs due to the truck driver shortage. That's been exacerbated by the strike on the west coast where truck drivers at ports, including those at Los Angeles and Long Beach, are protesting pay, benefits, and automation. About 40% of all goods shipped from overseas come through those two ports, which are the largest in the U.S. by container volume.
A trucker's strike and a slowdown by longshoremen on the West Coast is raising costs and risks for retailers everywhere. Photo: Flickr via tdlucas5000
If the cargo bound for the U.S. isn't unloaded -- longshoremen are engaged in a work slowdown at the ports -- or is not trucked across country, goods, appliances, and apparel consumers would normally expect to find in stores and on shelves won't be there, or it will cost retailers more to have it shipped by air.
This is the busiest time of the year at the ports, and the National Retail Federation estimates the impact of the job action could cost the U.S. economy some $2 billion a day. Dollar Tree could face a shortage of goods or even higher costs as a result, further pinching margins.
3. Its acquisition bid could be successful.
Dollar General (DG 3.36%) remains just as committed as Dollar Tree does to acquiring deep discounter Family Dollar (FDO +0.00%). Dollar Tree's risk comes if it actually wins the fight.
The two concepts, while similar, are very different in practice. Dollar Tree's stores price everything at $1; Family Dollar has a variety of price points. Dollar Tree's target demographic has been the middle-income consumer; Family Dollar, the lower income lower strata of the income ladder. Dollar Tree's operating margins are the highest of any of the dollar store chains; it acquisition target is the lowest.
Two steps back, one step forward if Dollar Tree successfully acquires Family Dollar. Photo: Flickr via Mike Mozart
There are other operational issues as well. While Dollar General is expected to have to close as many as 4,000 stores to get regulatory approval and Dollar Tree only 500, Family Dollar prefers Dollar Tree's offer because it keeps senior management in place. Dollar General has made no commitment about keeping on the management team those responsible for the dollar chain's decline. If Dollar Tree wins and keeps management on, there's little indication the poor performance would change.
Mostly green lights on highway to growth
While there are several reasons Dollar Tree can mitigate some of the risks that pose the greatest hurdles to its continued advance, investors would be wise to keep their eyes wide open about what happens if it merges with its rival. It could certainly implement better practices at its peer, but I'd remain wary nonetheless. In short, Dollar Tree and its investors could lose by winning the Family Dollar bidding game and that could cause its stock to tumble.
