It's hard to imagine a more boring business than the local five and dime. Of course, those have long since gone the way of the dodo -- or my luxuriant, wavy blond hair, for that matter. What we have today are dollar stores, and Dollar Tree (NASDAQ:DLTR) is one of the biggies.
Of course, boring investments often provide great opportunities. That's one of the reasons Dollar Tree received a nod as a recommendation in Motley Fool Inside Value.
Is there a decent value here today? Let's take a look.
On the surface, things look peachy. Sales up 14%. Net income up 13%. Earnings per share up 20%, owing to a sizeable reduction in share count fueled by share buybacks. Free cash flow for this quarter was much better than its prior-year counterpart, thanks to some major swings in working capital. I suspect some of that, like the ballooning in accounts payable, will be easing back in future quarters. Other working-capital shifts, like inventory reduction, could keep rolling; good on management for that.
But I have a hard time getting much more enthusiastic than that. Yeah, the results were decent, but to suggest that they represent an even bigger score because of the spike in gas prices just sounds like a stretch to me. (Couldn't one just as easily argue that rising gas prices will push consumers from higher-end stores in search of bargains at the buck shop?)
In fact, I think you might just find evidence of such a phenomenon in the drop in gross margins this quarter, which management attributed to a higher percentage of lower-margin goods in the sales mix (such as household consumables and foodstuffs). You can get all the details here, but gross margin dropped by half a percent, which resonated down the income statement.
The other big contributor to lowered gross margins -- increased freight and fuel costs -- highlights what I'd consider another kink in the business model. When you're fighting to be the cheapest store around, you don't have the luxury of passing on these kinds of costs to your customers. And unless you can absorb them through other advantages of scale, as stores like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) can, you may be stuck with a dwindling portion of your top line.
My problem with Dollar Tree is simple. It's a fairly priced, tidy little business in a tough field. When you're slugging it out with the aforementioned behemoths, as well the 99 Cents Only (NYSE:NDN), the Family Dollar (NYSE:FDO), the Dollar General (NYSE:DG), or the corner Walgreen (NYSE:WAG), you're engaged in one of those long, hard struggles to stay cheap.
That struggle tends to squish margins, big time:
| Margins % |
2000 |
2001 |
2002 |
2003 |
2004 |
2005 |
2006 |
|---|---|---|---|---|---|---|---|
|
Gross Margin |
36.8 |
36 |
36.4 |
36 |
36.4 |
35.6 |
34.5 |
|
Operating Margin |
15.2 |
10.3 |
10.9 |
10 |
10.5 |
9.4 |
8.4 |
|
Net Margin Ex Items |
7.3 |
6.2 |
6.6 |
6.1 |
6.3 |
5.8 |
5.1 |
|
Free Cash Flow Margin |
9 |
4.2 |
3.7 |
2.5 |
3.8 |
1.3 |
6.7 |
Investors can still make money in businesses like these; they just need to be extra picky about when they buy them. I think now is not the time. With tough comparable quarters coming up and increasing costs likely on the way, Dollar Tree may just give up the opportunity and miss by a penny next time around.
Take your lead from Dollar Tree's shoppers: Wait for a chance to get the most bang for your buck.
Dollar Tree and Wal-Mart are recommendations of Motley Fool Inside Value . Family Dollar is a Stock Advisor recommendation. Click the preceding links to try either premium newsletter service for free.
Seth Jayson is a cheap, cheap man. At the time of publication, he had no positions in any company mentioned here. View his stock holdings and Fool profile here. Fool rules are here.
