Sometimes, I think the IM exchanges between some of my Fool colleagues would provide sharper market commentary than what I can type up with too much time to think.
Case in point: this week's announcement from Dollar Tree (NASDAQ:DLTR) that it will be buying back $100 million worth of stock from Goldman Sachs (NYSE:GS).
"It's a waste," said my number-minded -- and normally far more polite -- Southern colleague David Meier.
And I'm afraid I agree. Here's the crux of the issue for me: Dollar Tree's returns on invested capital just aren't all that great, and they're getting measurably worse. By my calculations, they've dropped from the 32% level back in 2000 to the mid-teens today -- and this is before adjusting for operating leases. And when your returns on capital aren't so hot, it's pretty tough to justify spending money on share buybacks -- especially if you're buying back at a premium to market price. I might have accepted the rationale earlier in the year, when the stock was about $24 a share. Maybe. But now?
|
FY02 |
FY03 |
FY04 |
FY05 |
FY06 |
TTM | |
|---|---|---|---|---|---|---|
|
ROE |
20.5% |
33.2% |
35.0% |
16.5% |
14.9% |
15.3% |
|
ROIC |
25.8% |
44.0% |
32.4% |
15.9% |
15.0% |
14.3% |
I think Dollar Tree is plumb out of ideas, because if it could get a better return by investing in operations, the rational thing to do would be invest. But to me, the writing is already on the wall -- or make that my margin chart. Let's face it -- the low-end-selling biz is tough, and only the best can race to the bottom on price while seeing margins stay stable or rise. Just ask Wal-Mart (NYSE:WMT), Target (NYSE:TGT), Dollar General (NYSE:DG), or Family Dollar (NYSE:FDO). Here's the margins story at Dollar Tree:
|
FY 02 |
FY 03 |
FY 04 |
FY 05 |
FY 06 |
TTM | |
|---|---|---|---|---|---|---|
|
Grs. Mgn. |
36.6% |
36.2% |
36.4% |
35.6% |
34.5% |
34.0% |
|
Op. Mgn. |
10.9% |
10.0% |
10.5% |
9.4% |
8.4% |
7.8% |
|
Net Mgn. Ex-Items |
6.6% |
6.1% |
6.3% |
5.8% |
5.1% |
4.9% |
Which brings us back to the buyback. What will Dollar Tree get for that $100 million? "Approximately 2.7 million shares," according to the press release, plus an undetermined number of additional shares that will be delivered later. "We expect to receive additional shares before, and may receive additional shares upon, the anticipated three-month maturity of the program, depending on the market value of our common shares," the release states.
It had better be quite a few more shares, because, unless my calculator's busted, that original $100 million over 2.7 million stubs comes to $37 per share. Market price for these shares is currently $30 a stub. To get something close to current market value for its $100 million, Dollar Tree had better get somewhere around 3.3 million total shares from Goldman, or a full 600,000 more than it's getting up front. (For what it's worth, I value the shares at about $28 each.)
I put a call in to the folks at Dollar Tree's IR department for further explanation on this confusing-looking buyback, and they were nice enough to get back to me, but it was one of those calls where a few answers opened up even more questions.
The big one, for me, is: Why now? Why at this price?
Dollar Tree's answer wasn't very satisfactory. I have my own ideas. I hope it's not what I fear it could be: a sprint to hit year-end earnings-per-share goals.
Dollar Tree's execs are eligible to receive both cash bonuses based on EPS goals, and restricted-stock compensation -- the vesting of which is mostly dependent on meeting EPS targets. Last year (fiscal 2005), the execs received only about half of the potential award. Will they do better this year? Depends on what those targets are, right?
The filings don't appear to make clear exactly what those targets are, but there's little doubt that drying up the share pool via repurchases will help boost EPS. And while that, in and of itself, may not be a bad thing for investors, a better thing would be if Dollar Tree's execs were focused on finding the absolute best use of the firm's cash.
Given the dwindling returns on capital and shrinking margins, I don't think a share buyback meets that goal. If I were an investor in this outfit, I'd want to see that cash flow coming to me, in the form of dividends.
Dollar Tree is a Motley Fool Inside Value recommendation. To see a more bullish view on the company's prospects, a free trial is just a click away.
At the time of publication, Seth Jayson had no positions in any company mentioned here. View his stock holdings and Fool profile here. Wal-Mart is also an Inside Value pick. Family Dollar is a Stock Advisor selection. Fool rules are here.
