U.S. Markets closed

Why Dollar Tree Is Still Undervalued After Its Stock Price Gain

Despite recording a 39% rise in the last year, Dollar Tree Inc. (NASDAQ:DLTR) still has capital growth potential.

The budget retailer is investing in its store estate to improve the shopping experience for its customers, while its plans to stock a broader range of products could catalyze its long-term sales growth.

858913674.png


Store changes

The company opened a total of 150 new stores in the second quarter. This could expand its presence into new geographies and increase the size of its total addressable market.

In addition, the company renovated 542 stores in the second quarter. Its renovations included the inclusion of freezer and cooler doors alongside a broader selection of its products. Dollar Tree also updated the signage, lighting and decoration of its stores and improved its queuing lines at checkout in order to facilitate a faster shopping experience for customers.

The changes it has made to its stores led to a double-digit increase in comparative sales at its renovated stores in the second quarter. As it rolls out renovations across its wider store estate, it could experience an improved financial performance.

The company is increasing the prevalence of its private brand products across its store estate, as well as improving their labels and packaging. Private brand products provide the company with greater differentiation versus its sector peers, as well as higher margins when compared to the branded goods that it sells.

Growth opportunity

The business is currently engaged in a pilot program that seeks to broaden the price points of its products. The Dollar Tree Plus! test includes newly-added products at price points of between $2 and $5, with around 200 clearly identified products offering greater choice to the company's customers.

Dollar Tree's move toward offering a larger range of products at different price points could increase its appeal to a broader demographic and increase the size of its potential customer base. Additionally, it could increase the company's margins as it is able to select the most cost-effective products from a wider pool of options.

Its move toward a Dollar Tree Plus! business model could provide it with access to new product categories that have previously been unavailable at its $1 price point. This may lead to cross-selling opportunities for the business over the long run.

Potential threats

The company's gross profit margin declined 70 basis points in the second quarter in its Dollar Tree segment, while it fell 240 basis points in its Family Dollar segment. This was caused by higher costs, including rising labor costs. It expects labor costs to increase further in the second half of the current fiscal year. This could put pressure on its gross profit margin in the short run.

Alongside this, the company faces the possible threat of incremental tariffs on imports from China that could further reduce its margins. Tariffs may also lead to added pressure on consumer disposable incomes that reduce consumer confidence in the near term.

In response, the business is seeking to mitigate the potential impact of tariffs on its financial outlook. It has successfully offset previous tariffs on Chinese imports through price concessions with its suppliers, modified specifications of its products and an increasingly diversified list of vendors. According to its second-quarter update, there is scope for similar action to be taken by the business should its imports be subject to incremental tariffs.

Outlook

Analysts forecast Dollar Tree will report a 17% increase in earnings per share in fiscal 2021. Its forward price-earnings ratio of 22.4 suggests it offers capital growth potential following its stock price surge over the past year.

Disclosure: The author has no positions in any stocks mentioned.

Read more here:



Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.

This article first appeared on GuruFocus.