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A Look at Dollar Tree's Start to Fiscal 2019

- By The Science of Hitting

Dollar Tree Inc. (DLTR) reported financial results for the first quarter of fiscal 2019 on Thursday morning.

For the three-month period, same-store sales increased 2.2%, with a 2.5% increase for the Dollar Tree banner and a 1.9% increase for Family Dollar. It's worth noting that the Dollar Tree banner was lapping its toughest comparison from 2018 (same-store sales were up 4% in first-quarter 2018). On the other hand, Family Dollar was lapping its easiest comparison (same-store sales declined 1.1% for the banner a year ago). When management says "Family Dollar's 1.9% same-store sales increase is the strongest quarterly performance since we began reporting Family Dollar comps," it should be considered in that context. A look at the two-year stack is revealing (in orange):


As you can see, the Dollar Tree banner continues to report solid results. Family Dollar, on the other hand, is not showing any real sign of improvement. That's the opposite of management's proclamation that the turnaround is "gaining traction" (the truth is closer to what Duncan Naughton, the president and chief operating officer of Family Dollar, said on the call: "there is much more work to be done").

Some of the key work being done on the Family Dollar turnaround relates to the company's reimagined store design for both new locations and renovations (known as "H2"). Here's some commentary from Naughton on the conference call:


"Our acceleration of initiatives to optimize the Family Dollar real estate portfolio is delivering results. We are seeing meaningful improvement in operational performance across the footprint of renovated Family Dollar stores, resulting in increased traffic and low double-digit comp sales lifts... Comps are being driven two-third by traffic and one-third by average ticket... Customers indicate they're shopping more often and spending more for the improved assortment... Our survey feedback indicates H2 shoppers have a better overall shopping experience."



The problem is renovations take a long time (and cost a lot of money) when you have a footprint of more than 8,100 locations. For now, despite high hopes for H2 renovations, I'd argue Family Dollar, broadly speaking, is still muddling along with much room for improvement.

That shows up throughout the remainder of the income statement as well: Dollar Tree (banner) gross margins and operating (Ebit) margins were flat and down 20 basis points, respectively, in the quarter. Family Dollar gross margins and Ebit margins, on the other hand, were down 190 basis points and 200 basis points. Family Dollar's operating margin in the quarter was just 3.2% - a full 1,000 basis points lower than the Dollar Tree banner.

The weak Family Dollar results explain why, despite 5% operating income growth from the Dollar Tree banner, adjusted earnings per share for the company were down roughly 4% in the quarter (by comparison, earnings per share at Dollar General (DG) increased 9% in the first quarter).

This is impacting unit growth as well. Dollar Tree opened 91 stores in the first quarter (65 Dollar Tree and 26 Family Dollar) and re-bannered 45 stores to Dollar Tree (of the 200 planned for the full year). The total number of stores sits at 15,264, up 2% from a year ago. That reflects a 6% increase at Dollar Tree and a 1% reduction at Family Dollar. Yet again, the results are strong for the Dollar Tree banner (comparable to Dollar General) - but they are being held back at the consolidated level by Family Dollar. By the way, this is before considering the 140 Family Dollar locations closed after quarter-end, as well as an additional 150 locations the company expects to shutter by the end of July (those 290 units were equal to roughly 3.5% of the Family Dollar footprint at the end of the first quarter).

Across the board - on comps, margins, unit growth and capital allocation - this quarter clearly shows the impact buying Family Dollar is still having on Dollar Tree - especially relative to its closest peer, Dollar General. What should be a clean story of consistent low single-digit comps, new stores with attractive unit economics and share repurchases driving high single-digit or double-digit earnings per share growth remains muddied by the continued turnaround efforts at Family Dollar. And with each passing quarter, it becomes clearer management has no intention of changing that.

The other major initiative underway at the company is the start of the multiprice-point test at the Dollar Tree banner. CEO Gary Philbin discussed its progress on the call:


"We spent the past several months, laying the groundwork for this test, carefully and thoughtfully designed a test that we believe will allow us to measure the impact of different price point items and categories on shopping behavior, store profitability and our loyal customers affinity for the Dollar Tree brand. We will be offering a range of items across a number of categories, we will be testing primarily at [full] price points of $3, $4 and $5... the price will be displayed in four foot sections or end-caps clearly branded as Dollar Tree Plus, in order to minimize confusion... The test officially launched a few weeks ago... We are in the process of rolling out to more than 100 test stores... we do not have a set time frame for the test. It's in the early days right now, but we will have more details to share on our progress in the future."



Last quarter, I said that I believed management was doing little more than paying lip service to the idea (which was proposed by activist investor Starboard Value). It's still early, and we will see how this evolves over time, but I'm still doubtful anything comes from this anytime soon.

Conclusion

I don't think anything material changed with these results. As such, I'll stick with what I said back in March: "I don't plan on buying the stock near current levels. That would likely change if Mr. Market became more pessimistic and pushed Dollar Tree stock back towards a price where I felt I was wasn't paying much - or anything - for the Family Dollar business (call it under $90 per share)."

For now, we wait.

Disclosure: None.

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This article first appeared on GuruFocus.