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Dollar Tree Might Need an Activist Investor to Make Stock a Buy

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Dollar Tree  (DLTR) - Get Free Report may be trading down of late, but it may need structural changes in the company before the stock can resume growing.

After poor fourth quarter results and guidance that disappointed Wall Street, the stock fell 2.70% to $79.54 Wednesday. The stock had already been down 9.6% for the year heading into earnings, a far worse decline than the S&P 500’s fall so far in 2020.

For the fourth quarter, Dollar Tree reported same-store-sales growth of 0.4%, against analysts esteems of 1.7% and revenue of $6.32 billion, against expectations of $6.385 billion. Management said the shortened holiday season was partially to blame. Gross margin was pressured by tariffs, falling to 31% from 31.5% in last year’s holiday quarter.

Family Dollar Store, which sells products ranging in price from $1 to $10, saw a 0.8% decline in same-store-sales, with management noting a tough comparable against last year’s result. The poor result, coupled with higher expenses like salaries, drove the segment’s operating margin down year-over-year to 3.1%. This hurt the overall operating margin, which fell to 9.2% from 10.2% last year.

Guidance was also not satisfactory to analysts and investors alike.

Management is looking for full year 2020 revenue of a midpoint of $24.44 billion, just lagging Wall Street estates, as is usually the case for the company. 

Same-store sales are forecast at low dingle digits in percentage terms. Analysts want to see 2.3% growth.

The company is looking for EPS for the year of $4.98 against Wall Street estimates of $5.25. Importantly, the lower EPS guidance does not reflect share buybacks, a positive, but the number is still a disappointment. Management said a $57 million tariff impact is pressuring gross margins. 

But here’s where the story gets tricky. 

The stock remains pressured because some involved with the company have spoken about the “break-the-buck” trend, especially in the Family Dollar store, which is roughly half of revenue. Break the buck means raise prices, or tilt more towards selling $10 items. This would support margins. Of course, volumes are also important and one risk to the company most analysts cite is the productivity of Family Dollar stores. 

Management said on the earnings call that it wants to sell more discretionary — higher priced — goods and as it prepared to do so for 2020, its Q4 results slipped. 

On price in general, “there are hints in the commentary of a tentative commitment to some break the buck activity in Q2-Q$ 2020,” wrote Alliance Bernstein analyst Brandon Fletcher in a post earnings note. “However, if Dollar Tree was truly committed to break the buck, that growth [shown in guidance], should be much higher.” 

Fletcher added: 

“We believe a functional Dollar Tree is more defensible than Target with the right management. What we have done with pricing and operations at other retailers can and should be don at Dollar Tree to get the full growth potential out of this company. We are now looking for an activist willing to make the changes that are necessary.” 

Fletcher compares Dollar Tree to Target  (TGT) - Get Free Report, which trades at 16 times forward earnings, just above Dollar Tree’s 15 times, which has fallen from its recent average in the midst of all of these headwinds. 

Hedge fund Starboard Value tried to launch a proxy fight in early 2019, arguing that management needed to make strategic changes. The fund walked away from the fight in April 2019. 

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