Money Really Does Grow on Trees at Dollar Tree

Dollar Tree NASDAQ: DLTR has had a heck of a run over the past year. The discount retailer is among the biggest beneficiaries of our pandemic-driven shopping habits. A wide product assortment including cleaning supplies and PPE along at affordable prices has made it a go-to destination for many consumers. In the process Dollar Tree stock climbed to a record high above $120 last month.

However, following this morning's earnings report, Dollar Tree is trading back below $100 for the first time since early March. Does this mean the rally is over? Or is the downturn an opportunity to load up the basket with some discounted shares?

 How Were Dollar Tree's First Quarter Earnings?

Dollar Tree's first-quarter revenue increased 3% to $6.48 billion topping the Street's estimate of $6.42 billion. Same-store sales rose 0.8% which also surpassed the Street's forecast for a 0.6% decline. Earnings per share (EPS) were up 54% to $1.60 and beat the consensus expectation by $0.18.

It was hard not to like the quarter. Not only did the company post record earnings and beat on the top and bottom line, but the market was braced for a same-store sales decline given the tough comparison to the stockpiling first quarter of 2020. Same-store sales were up 4.7% in the core Dollar Tree business, but down 2.8% at Family Dollar locations.

But what the market wasn't keen on was management's profit guidance. It said it sees full-year EPS of $5.80 to $6.05 along with comparable sales growth in the low-single digits. The EPS forecast was significantly below the analyst consensus of $6.23.

Management cited elevated freight costs as the main reason behind the soft guidance. In the last three quarters of the fiscal year, freight costs are expected to be $0.70 to $0.80 above the same period a year prior. This stems from high demand, driver shortages, and other COVID-19-related transportation industry challenges that are largely expected to be fleeting.

What are Dollar Tree's Growth Sources?

Dollar Tree acquired Family Dollar back in 2015. Although the $9 billion purchase price was considered reasonable at the time, Family Dollar has weighed on its parent company. The addition of Family Dollar was supposed to strengthen the company's competitive position against rival Dollar General and other major retailers.

To strengthen the Family Dollar side of the business, Dollar Tree embarked on a path of closing underperforming locations, renovating many, and converting others to Dollar Tree stores. Progress has been made.

In the most recent quarter, the Family Dollar segment recorded $211.4 million in operating profit, its best mark since the merger. Over on the Dollar Tree side of the business, profitability is also on the rise. The operating margin expanded by 2.9%, no small feat given the low margin nature of the business.

To generate bottom line growth going forward, Dollar Tree will have to continue to find ways to enhance its profit margins. A key component of the strategy is the company's new Dollar Tree Plus! Concept. A departure from the traditional 'all items for $1' approach, Plus! is introducing multiple price points to the stores allowing Dollar Tree to carry a broader range of products—and stretch gross margins. The concept has been incorporated into 240 stores including those in Colorado, Georgia, Alabama, Louisiana, and the Carolinas.

Of course, to thrive in an increasingly e-commerce focused economy, Dollar Tree must continue to develop its online storefront. Last year it launched the FamilyDollar.com website to complement its DollarTree.com site. Joining forces with Instacart has helped. And although it remains to be seen if shoppers will continue to lean on same-day delivery services for groceries in the post-pandemic world, people seem to crave convenience as much as safety these days.

Another place the company can potentially improve profits is to surrender to the self-checkout lane. It has thus far avoided the popular supermarket staple, but recently initiated a pilot self-checkout program at a few stores. This could help reduce labor costs and drive a better bottom-line performance. Meanwhile, the Family Dollar division is exploring the possibility of adding fresh produce and frozen meats to attract more customers.

Is the Dollar Tree Pullback a Buy Opportunity?

The post-earnings selloff is a classic overreaction to a strong quarterly report with soft guidance. Management's outlook is likely on the conservative side owing not only to shipping costs but the still uncertain economic environment. Keep in mind Dollar Tree has topped earnings expectations for six straight quarters. It will probably extend that streak next quarter and spark the next leg up in the rally.

From a technical analysis perspective, Dollar Tree now has a relative strength indicator (RSI) of approximately 15. It has also fallen below the lower Bollinger band. The last time these events simultaneously occurred (late February/early March), the stock went on a 25% run in four weeks. This stage could be soon set for a similar rebound.

Buying Dollar Tree under $100 is looking like a good move given the company's recent performance and potential for market share gains as it looks to draw customers away from the Krogers and Walmarts of the world.