It has been about a month since the last earnings report for Dollar Tree (DLTR Quick QuoteDLTR - Free Report) . Shares have lost about 6.9% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Dollar Tree due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important catalysts.

Dollar Tree Q3 Earnings Beat, Sales Lag Estimates

Dollar Tree posted mixed third-quarter fiscal 2021 results, wherein earnings beat the Zacks Consensus Estimate, while sales lagged the same. Meanwhile, sales improved year over year, but earnings declined. Higher-than-expected freight costs in the reported quarter primarily hurt bottom-line growth and the gross margin. Compelling results from the H2, Dollar Tree Plus and the new Combo Stores, which are part of the company’s key initiatives, drove the third-quarter fiscal 2021 performance.

The company expects elevated freight costs to create headwinds in the near term. Consequently, it narrowed its sales and earnings per share guidance ranges for fiscal 2022. This resulted in negative investor sentiments upon the company’s earnings release, leading to shares of Dollar Tree declining 1.9% in the pre-market session on Nov 23.

Quarter in Detail

Dollar Tree’s earnings declined 30.9% year over year to 96 cents per share but surpassed the Zacks Consensus Estimate of 95 cents. The year-over-year decrease can be attributed to the higher-than-anticipated freight costs witnessed in the quarter, which led to a gross margin decline. However, earnings per share were better than expected, owing to strong performance across its business. The company delivered earnings per share toward the high-end of the previously anticipated range of 88-98 cents per share.

Consolidated net sales rose 3.9% year over year to $6,417.7 million but lagged the Zacks Consensus Estimate of $6,423 million. Enterprise same-store sales (comps) improved 1.6% year over year and 6.7% on a two-year basis. For the Dollar Tree banner, comps were up 0.6% on a constant-currency basis and 0.8% after adjusting for the impacts of Canadian currency fluctuations. Soft comps stemmed from weak performances at Dollar Tree and Family Dollar segments. Comps for the Family Dollar banner rose 2.7% compared with robust 6.4% comps growth in the prior-year quarter.

Gross profit declined 8.3% year over year to $1,763.7 million, while the gross margin contracted 370 bps to 27.5%. The gross margin decline can be attributed to elevated freight costs, partly negated by continued improvement in shrink. The gross margin contracted 470 bps to 30.2% at the Dollar Tree banner and 240 bps to 24.4% at the Family Dollar segment.

Selling, general and administrative (SG&A) expenses, as a percentage of sales, declined 100 bps to 22.7%, driven by reduced COVID-related costs compared with the last year. In the year-ago quarter, the company incurred COVID-related costs of $35.3 million (or 57 bps).

While operating income declined 33.3% to $310.5 million, the operating margin contracted 270 bps to 4.8%, driven by a soft gross margin, partly offset by a lower SG&A expense rate. Segment-wise, the operating margin contracted 420 bps to 8.5% for Dollar Tree and 160 bps to 3% at the Family Dollar segment.

Balance Sheet

Dollar Tree ended the quarter with cash and cash equivalents of $701.4 million. Net merchandise inventories increased 13.8% to $4,316 million. It had net long-term debt (excluding current maturities) of $3,231.1 million and shareholders’ equity of $7,244.4 million as of Oct 30, 2021. Outstanding debt as of the quarter-end was $3.25 billion.

In third-quarter fiscal 2021, the company did not repurchase any shares as it was focused on launching its broader nationwide $1.25 price point initiative. In the first nine months of fiscal 2021, the company bought back 9,156,898 shares for $950 million. As of Oct 30, 2021, the company had $2.5 billion remaining under its existing authorization.

For fiscal 2021, it expects to incur a capital expenditure of $1.1 billion. It anticipates utilizing the majority of the excess cash flow generated to repurchase shares under the aforementioned program.

Store Update

In third-quarter fiscal 2021, Dollar Tree opened 125 stores, expanded or relocated 34 outlets, and shuttered 23 stores. It completed the renovation of 450 Family Dollar stores to the H2 or Combo Store formats. As of Oct 30, 2021, the company operated 15,966 stores in 48 states and five Canada provinces.

Key Real Estate Initiatives Update

Dollar Tree is delivering compelling results for its key initiatives, including the expanding footprint of the H2, Dollar Tree Plus and Combo Stores. The Family Dollar H2 stores have been performing well, with about 450 Family Dollar stores renovated to the H2 format in the fiscal third quarter. It currently has 3,300 Family Dollar H2 stores. In fiscal 2022, the company expects to complete 800 Family Dollar H2 Renovations as part of the Key Real Estate Initiative.

Its multi-price point Dollar Tree Plus concept store is gaining popularity among customers, particularly discretionary categories. This has helped improve store productivity. Consequently, the company plans to accelerate the Dollar Tree Plus initiative by adding an additional 1,500 stores in fiscal 2022. It expects to have at least 5,000 Dollar Tree Plus stores by the end of 2024. It is on track to have 500 Dollar Tree Plus stores by the end of fiscal 2021.

The company’s newest format store — Combo Store — which leverages the strengths of both banners under one roof has exceeded expectations. Dollar Tree currently has 105 Combo Stores in operation. The company believes that it has an opportunity for up to 3,000 Combo Stores in rural areas. Driven by the positive response, it expects the Combo Store to be the key strategic format, anticipating 85% of the newly opened Family Dollar stores to be Combo Stores in fiscal 2022. Thus, it expects 400 new or renovated Combo Stores for fiscal 2022.

Additionally, the company plans to move away from its $1 pricing constraints and provide more value to customers through its $1.25 price point initiative. It plans to aggressively roll out the $1.25 price point to all Dollar Tree stores, with the new pricing introduced in more than 2,000 stores in December and all legacy Dollar Tree stores by the end of first-quarter fiscal 2022. The latest pricing initiative is expected to enhance the company’s ability to expand its offerings, introduce products and sizes, and provide families with more of their daily essentials. It will enable the company to reintroduce some of the customer favorites and traffic-driving products that were discontinued earlier due to the $1 pricing constraint.

Outlook

For fourth-quarter fiscal 2021, Dollar Tree expects consolidated net sales of $7.02-$7.18 billion, with comps growth in low-single digits. It anticipates earnings of $1.69-$1.79 per share.

For fiscal 2021, the company expects net sales of $26.25-$26.41 billion compared with $26.19-$26.44 billion mentioned previously. It continues to expect comps growth in low-single-digits. Management now envisions earnings of $5.48-$5.58 per share, down from $5.40-$5.60 per share mentioned earlier. The narrowed earnings forecast was primarily due to the elevated costs that the company witnessed in the fiscal third quarter. It expects to offset the higher freight costs through gains from the transition of the Dollar Tree stores to the $1.25 price point. However, gains will be partially negated by the one-time costs incurred for the transition of the stores.

Although transpacific ocean container rates have been in focus lately, Dollar Tree notes that it is being impacted by all aspects of freight, including higher costs for inland transportation by truck and rail. In the fiscal third quarter, the company moved more containers than anticipated, incurring higher-than-expected freight costs. The company expects the freight and supply-chain disruptions to remain the greatest challenge in the near term.

The company’s Dollar Tree banner is extremely sensitive to higher freight costs due to its one-dollar price point. It is taking several steps to mitigate the impacts of higher freight costs and improve the gross merchandise margin to overcome the situation.

How Have Estimates Been Moving Since Then?

It turns out, estimates revision have trended upward during the past month.

VGM Scores

At this time, Dollar Tree has a subpar Growth Score of D, however its Momentum Score is doing a bit better with a C. Charting a somewhat similar path, the stock was allocated a grade of B on the value side, putting it in the top 40% for this investment strategy.

Overall, the stock has an aggregate VGM Score of C. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending upward for the stock, and the magnitude of these revisions looks promising. Notably, Dollar Tree has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.