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Family Dollar Driving Dollar Tree Higher

Rich Duprey, The Motley Fool

Will Family Dollar become the growth engine that drives Dollar Tree (NASDAQ: DLTR) forward? The deep-discount chain posted its best quarter since it was acquired by its rival in 2015, and though much work remains to be done with the retailer, the confidence management placed in the chain looks as if it is finally paying off.

Not that the turnaround is coming without cost. While Dollar Tree sales beat analyst expectations in the second quarter, profits fell short due to markdowns at Family Dollar and the writedown of costs associated with store closings. Dollar Tree closed almost 300 Family Dollar stores during the period and rebannered over 100 Family Dollar stores to Dollar Tree.

Dollar Tree reported revenue of $5.74 billion, up 3.9% from the $5.53 billion it posted in the year-ago quarter as comparable store sales rose 2.4%. Family Dollar also posted a 2.4% gain in comps, its best showing in four years, and ahead of the 1.9% gain in the first quarter and the flat result it had last year. It's the third straight quarter of sequentially rising sales at the chain.

Dollar bills in a tree

Image source: Getty Images.

Making a U-turn

It's a marked change for Family Dollar, which seemed poised to be axed. While Dollar Tree management hadn't been on board with shedding the chain, activist investor Starboard Value was saying it was time to cut losses and put Family Dollar up for sale. But management was able to convince the hedge fund the policies it was implementing were working, and the PE firm said it would hold off on its call to separate the chain.

That seems to have been a smart move, though there is an argument to be made that discounting is driving at least some of the traffic to stores and that once it stops, comps might weaken again.

The costs are adding up, as Dollar Tree's net income was just $180.3 million, or $0.76 a share, compared to $273.9 million a year ago, or $1.15 per share, and short of analyst expectations of $0.83 per share.

Getting smaller to do better

One of the things helping Family Dollar move forward is remodeling. The deep discounter says renovated stores enjoy substantial double-digit increases in comps, and after remodeling 350 Family Dollar stores in the first quarter, it renovated an additional 542 stores in the second. The success these remodels are generating led Dollar Tree to say it will now renovate 1,150 stores this year instead of the 1,000 it originally planned to update. Most of the remaining remodels will occur in the third quarter.

Closing down some Family Dollar stores, renovating others, and dealing with the impacts of higher transportation costs and tariffs are taking a toll, though. Dollar Tree has narrowed its full-year outlook on sales, raising the bottom end of its guidance to $23.57 billion from $23.51 billion, but lowering the high end from $23.83 billion to $23.71 billion.

It still thinks comps for the year will be in the low single digits, but the amount of selling square footage available has increased by 1.3% over last year versus the 1% increase it previously saw.

That's still going to hit earnings, which it now expects to be in a range of $4.90 to $5.11 per share as opposed to the outlook of $4.77 to $5.07 per share it reported after the first quarter. It again raised the bottom end while lowering the top.

Still a wait-and-see situation

However, Dollar Tree looks to be in a better position than it was a year ago, and if Family Dollar can continue on this path to better sales again, it could help drive the business as a whole higher. Because the gains seem to be predicated at least in part on discounting, the results might not be as sturdy as they otherwise appear. It's heading in the right direction, but the results are as messy as they were expected to be. 

It's going to take a few more quarters at least before we get to see the renewed Dollar Tree, but this preliminary view suggests it will be a more solid company this time next year.

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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com