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Dollar Tree (DLTR) Up 31% in a Year: Will Momentum Sustain?

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Dollar Tree, Inc. (DLTR - Free Report) is benefiting from initiatives like Dollar Tree Plus! test and store-optimization efforts. Moreover, the company has been displaying remarkable comparable-store sales (comps) growth.

A glance at this Zacks Rank #3 (Hold) stock’s price performance shows that it has gained 31.3% in a year compared with the industry’s 21.4% growth. Further, a VGM Score of A with an expected long-term earnings growth rate of 10% highlights the stock’s inherent potential.

Factors Driving Dollar Tree’s Performance

Dollar Tree is undertaking significant store renovation initiatives for Family Dollar to attract more customers. In this regard, management has launched H2 — the latest model for new and renovated Family Dollar stores internally. This model has boosted traffic and led to average comps growth in excess of 10% over control stores. Further, the company expects to renovate at least 1,000 stores in fiscal 2019.

Moreover, it is on track to close underperforming Family Dollar stores. Annually, the company is closing about 75 Family Dollar stores. In fiscal 2019, it plans to close 390 stores, majority of which will take place in the second quarter. The company plans to re-banner about 200 Family Dollar stores to the Dollar Tree locations in fiscal 2019. Furthermore, it has plans to install adult beverages in roughly 1,000 Family Dollar stores, and expand freezers and coolers in roughly 400 Family Dollar outlets in fiscal 2019.

In addition, the company’s restructuring and expansion initiatives, as evident from steady store openings and improvement of distribution centers, are likely to drive revenues. These actions place Dollar Tree on track to reach its long-term target of operating 26,000 stores, with more than 10,000 Dollar Tree and 15,000 Family Dollar outlets across North America. The company intends to open a distribution center in Rosenberg, Fort Bend County, TX, in fiscal 2019.

In a bid to boost sales and margins, Dollar Tree announced its intention to add merchandise with higher price points to its stores. The company is formulating tests to measure the impact of different price points, items and categories, store profitability and the affinity of loyal customers for the Dollar Tree brand. As part of the tests, the company will leverage Family Dollar and Dollar Tree distribution center systems and combined merchandise to efficiently get the new products into Dollar Tree stores without disrupting normal operations.

The company plans to offer merchandise at price points of $3, $4 and $5, which will be displayed in end caps clearly branded as Dollar Tree Plus! to minimize confusion with the dollar value offerings that are familiar to customers. The test is basically not intended toward raising prices of products in the Dollar price point but adding new items and categories with the higher price points to boost margins and sales. With the first batch already launched, the company is on track to roll these tests to more than 100 test stores in the near future.

Apart from these, the company’s comps remain robust mainly due to competitive pricing and its store expansion plans, which include remodeling and relocations. It continued the positive trend as enterprise comps for first-quarter fiscal 2019 improved 2.2%. In fact, Dollar Tree stores marked the 45th straight quarter of comps growth. Notably, the newly renovated Family Dollar stores are delivering strong performance, which is also driving overall comps. The company anticipates comps growth in low-single-digits for both second-quarter and fiscal 2019.

Possible Deterrents

However, the company is grappling with soft margins due to higher costs. In the first quarter, gross margin contracted 90 basis points (bps) due to lower initial markup at Family Dollar, increased domestic freight and distribution costs, shrink in the Family Dollar segment and increase in occupancy costs related to increased rent expense for Family Dollar stores scheduled to close in 2019. Further, adjusted operating margin declined 130 bps in the fiscal first quarter on account of soft gross margin and higher SG&A costs.

Apart from higher costs for the newly negotiated freight rates, the company expects continued pressure on store payroll, states increasing minimum wages and completion of its ongoing initiatives to weigh on margins in fiscal 2019. Notably, it predicts domestic freight costs (as a percentage of sales) to increase in the first half of the year and then flatten out in the second half.

Also, Dollar Tree narrowed its earnings view for fiscal 2019. The company projects consolidated net sales of $23.51-$23.83 billion compared with the previous guidance of $23.45-$23.87 billion. Earnings are envisioned to be in the band of $4.77-$5.07 per share compared with the prior guided range of $4.85-$5.25, including discrete expenses of about $95 million related to the Family Dollar store optimization initiative and store support center consolidation.

Nonetheless, we expect all aforementioned factors to offset these hurdles and help the company sustain its momentum.

Key Picks

Target Corporation (TGT - Free Report) has a long-term earnings growth rate of 7.1% and a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Ross Stores, Inc. (ROST - Free Report) has a long-term earnings growth rate of 10.4% and a Zacks Rank #2.

The TJX Companies, Inc. (TJX - Free Report) has a long-term earnings growth rate of 10.9% and a Zacks Rank #2.

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