Dollar Tree (DLTR, Financial) recently reported results for the second quarter of fiscal 2020. For the quarter, consolidated comparable store sales (comps) increased by 7% year-over-year (same as the first quarter), reflecting a double digit increase at Family Dollar and a return to growth at Dollar Tree.
Starting with the Dollar Tree banner, comps increased by 3% in the quarter, with a 23% increase in average ticket offset by a mid-teens decline in transactions as consumers focused on stock-up trips. As management noted on the conference call, this reflected sequential improvement in every line of business at Dollar Tree except for food, which was negatively impacted by some supply chain issues and fewer shoppers in the store (which was a headwind to impulse purchases like snack foods).
After its best quarter – by far – since the acquisition in 2015, Family Dollar delivered strong results again in the second quarter. For the quarter, comps increased 12%, with a 26% increase in average ticket offset by a low double-digit decline in traffic. Growth in the quarter reflected the continued impact of households stocking up on essentials like paper goods and cleaning supplies (consumables +6% overall), as well as nearly 30% growth in discretionary categories (with significant help early in the quarter from the disbursement of stimulus dollars and tax refunds).
As shown below, the strength at Family Dollar in the first half of the year and a second quarter rebound at Dollar Tree has led to strong results, with enterprise two-year stacked comps up 10%.
The increase in consolidated comps was the primary driver of a 9% increase in revenues to $6.3 billion in the quarter. The company ended July with 15,479 total locations, up 2% year-over-year (reflective of a 5% increase in Dollar Tree units and a marginal increase in Family Dollar units).
On a consolidated basis, gross margins expanded by 180 basis points in the quarter to 30.5%, reflective of lower freight costs and occupancy costs (as a percentage of revenues), as well as reduced markdowns and an improvement in shrink. The company saw slight deleverage on SG&A from Covid-19 related costs. The net result was a 130 basis point improvement in consolidated operating margins, resulting in a 39% increase in operating income to $375 million. The strong second quarter results have led to a low teens increase in adjusted earnings per share (EPS) for Dollar Tree through the first six months of the fiscal year.
In the second quarter, the company opened 105 stores (net of closures) and completed 76 Family Dollar renovations to the H2 format (to date, they've completed nearly 300 H2 renovations in 2020). Importantly, comps at the renovated Family Dollar stores continue to outpace the chain average by more than 10%. On the call, management indicated that they still plan to open 500 new stores throughout the year, on top of 750 H2 renovations. As newly appointed CEO Mike Witynski (who abruptly took over in July from former CEO Gary Philbin) noted on the call, they will look to accelerate this pace when able to do so:
"We're trying to do as many as we can given the current environment of travel restrictions and COVID restrictions. We're going to do 750 this year. But, absolutely, as soon as the states open up and it's safe and we can get our third parties and our teams in there to do the remodels, we will absolutely open that back up and accelerate that."
Personally, given the fact that Family Dollar is seeing material benefits to its business from the pandemic, with new and lapsed customers coming into its stores, as well as the continued comp uplift being delivered at H2 stores, its hard to argue with that decision. While I've voiced my concerns in the past about the validity of the Family Dollar deal, the reality is that's water under the bridge now. This business isn't going anywhere in the foreseeable future. Given that, I think it makes sense for management to aggressively press forward with H2 renovations.
The strong financial results delivered in the first half of the year have helped the financial picture as well. At quarter end, the company held $1.8 billion in cash and equivalents compared to $4.1 billion in total debt ($2.3 billion net). To put that number in context, the company held $4.4 billion in net debt two years ago (at the end of the second quarter of fiscal 2018).
Despite this improvement in the balance sheet, it sounds like the company isn't likely to resume repurchases (at least for now). As CFO Kevin Wampler stated on the conference call, "we'll keep our eye on those type of things and make some decisions as we enter the new year."
Conclusion
In the past few years, Family Dollar has struggled while the namesake Dollar Tree banner has continued chugging along. That changed in the first quarter of 2020, with Family Dollar benefiting from the pandemic while Dollar Tree reported its first quarter of negative comps in many years. In the second quarter, Family Dollar maintained its double digit comps growth, while Dollar Tree moved back into positive territory as well. In addition, the balance sheet has also returned to a position where the company can consider playing offense again. In summary, I think there are a lot of encouraging signs in the busines right now.
The big question, in my mind, continues to be Family Dollar. Are the first half results indicative of real and sustained improvement or a temporary tailwind from the pandemic? While I don't know the answer, I am encouraged by the strength reported in the quarter, particularly in the discretionary category. In addition, at $90 per share, I do not think Mr. Market is asking me to pay much for the Family Dollar banner (as I've noted in the past, I think the Dollar Tree banner alone is worth at least $80 per share). Said differently, I think today's price may offer a cheap option on a turnaround at Family Dollar – and we may be seeing early signs of success at the banner (the counter argument to that is FDO continues to lag its closest peer, Dollar General (DG), by a wide margin).
As Mr. Witynski noted on the call, "It's a new day at Family Dollar."
If he's right, there's a lot of upside on this investment in the coming years.
Personally, I need to see more evidence that the Family Dollar results can be sustained, or a cheaper stock price, before I'd invest in Dollar Tree. For that reason, I'm not a buyer - yet.
Disclosure: None
Read more here:
- Ollie's: 'Our Best Quarterly Results in Our 38-Year History'
- Does 'Don't Lose Money' Hurt Berkshire Shareholders?
- Berkshire Hathaway: A Satisfactory First Half of the Year
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