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Dollar Tree Down 18% in 3 Months: Can Efforts Aid Revival?

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Dollar Tree, Inc. DLTR has been witnessing strained margins, high costs and tariffs. Investor sentiment for the stock was further hurt by dismal third-quarter fiscal 2019 earnings, which were impacted by cost deleverage and soft margins. Moreover, the company lowered its guidance for fiscal 2019 based on anticipated impacts of tariffs.

A glimpse at the Zacks Rank #4 (Sell) stock’s price performance reveals that it has underperformed the industry in the past three months. Shares of this Chesapeake, VA-based company have lost 18.2%, against the industry’s growth of 4%.

Moreover, unimpressive estimate revision trend for the fourth quarter and fiscal 2019 drives pessimism. Over the past 30 days, the Zacks Consensus Estimate for earnings has moved down by 14% and 6.8% for the fourth quarter and fiscal 2019, respectively, to $1.78 and $4.73 per share.

Reasons Behind Dollar Tree’s Dismal Run

Dollar Tree continued to witness soft margins in the fiscal third quarter, which marked the seventh straight quarter of soft gross and operating margin performance. In the quarter, gross margin contracted 50 basis points (bps) due to increased freight and distribution costs, higher sales of low-margin consumable merchandise primarily in the Family Dollar segment, and increased shrink. Further, operating margin declined 80 bps due to soft gross margin and higher SG&A costs.

Dollar Tree expects incremental pressure on merchandise margin due to lower-margin consumables growing faster than planned, payroll costs in distribution centers, and increased run rates for repairs and maintenance, utilities and depreciation to affect fiscal fourth-quarter performance.

Management issued guidance for the fiscal fourth quarter, which is lower than the previous one. The soft fourth-quarter view is mainly based on the impacts of the Section 301 tariffs, which were announced prior to second-quarter fiscal 2019 results. The company expects the Section 301 tariffs to increase cost of goods sold by $19 million (or 6 cents per share) in fourth-quarter fiscal 2019, if implemented.

Due to the tariff impacts and the aforementioned cost woes, the company projects net sales of $6.33-$6.44 billion in the fiscal fourth quarter. Further, it expects earnings per share, including tariff costs, of $1.70-$1.80 for the quarter.

Moreover, the company lowered the outlook for fiscal 2019. It projects consolidated net sales of $23.62-$23.74 billion for fiscal 2019 compared with the previous guidance of $23.57-$23.79 billion. It now envisions earnings of $4.66-$4.76 per share versus $4.90-$5.11 guided earlier. This includes discrete costs of 28 cents per share, store closure related costs of 5 cents and tariff-related costs of 6 cents.

Can Efforts Aid Revival?

Despite the odds, the company expects the strength in Dollar Tree and Family Dollar banners to continue. Within the Dollar Tree segment, the company remains keen on delivering ever-changing and new product ideas that drive customer engagement. This has led to an increase in both traffic and ticket at stores, with the former slightly outpacing the ticket increase in the fiscal third quarter. Among the company's initiatives, the most prominent are the introduction of Hallmark cards section, the Crafters Square program and Snack Zones across the Dollar Tree chain stores.

The company is also undertaking Dollar Tree Plus! Tests to assess the impact of merchandise and categories with price points of $2, $3, $4 and $5, across 115 Dollar Tree brand stores. The test is not intended toward raising prices of products in the Dollar price point but adding new items and categories with higher price points to boost margins and sales.

Moreover, the company is on track with the integration of Family Dollar that was acquired in July 2015. It is undertaking significant store renovation initiatives for Family Dollar to attract more customers.

As part of its store optimization program for the Family Dollar brand, the company is rolling out H2, a latest model for the new and renovated Family Dollar stores, internally. These renovations are likely to boost traffic at stores, thus lifting average comps. The company had nearly 200 H2 stores at the beginning of fiscal 2019. During the fiscal third quarter, it completed the renovation of 247 Family Dollar stores to the H2 format. The company targets 1,150 Family Dollar H2 renovations for fiscal 2019. Further, it now plans more than 1,000 Family Dollar H2 renovations for fiscal 2020. It is also on track to close underperforming Family Dollar stores.

We believe the aforementioned factors to help the stock win back investors’ confidence.

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