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Buying Retail Stocks During COVID? Consider Discount Retail, Goldman Says

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Sure, the best stock plays for the entirety of the Coronavirus pandemic have been growth tech and consumer staples. 

But let’s apply the idea of the efficient market. Investors quickly recognized that opportunity and have sent those stocks soaring, driving them to frothy valuations. For those looking for value elsewhere, Goldman Sachs retail analysts advocate for Dollar Tree  (DLTR)  and Dollar General  (DG) . The reason: these two companies can take broader retail market share if consumers are prone to watching their wallets during the pandemic and as the economy recovers, which may take over a year. 

“We think what ultimately drives these stocks in 2020 and into 2021 is their focus on value in a trade-down economy, opportunities for share gains as other pockets of retail are only just emerging from government mandated closures, and potential for top-line and margin expansion in light of these tailwinds as we look to 2021,” wrote analyst Kate McShane in a note. "We recommend Dollar Tree, Dollar General.”

In the beginning of the year, Walmart  (WMT)  and Costco  (COST)  looked attractive after they had fallen off, along with the broader market, as the virus reached the U.S. and caused lockdowns across the country. But investors quickly realized state’s allowance of essential services would enable consumers to stock up on staples items. Those stocks are now up around 5% for the year — the S&P 500 down 7.5% — and trading at earnings multiples relatively expensive to their histories. McShane noted the valuation concerns on Walmart, after its better-than-expected earnings report, which preceded a 2% move down in the stock the day after earnings.

Meanwhile, Dollar General and Dollar Tree may look a little more, attractive, especially Dollar Tree.  

Let’s start with Dollar General. 

The stock is indeed up 15% year-to-date and trading at roughly 22 times next year’s earnings estimates, above its 5-year historical average of 17.5 times. Earnings estimates for 2021 are for 14% year-over-year growth, not huge growth compared to the S&P 500, but the index seems to have priced in much of the 2021 action, should there be no second wave of infections and lockdowns. So should the market find the right multiple for Dollar Tree soon, the stock could end the year up nicely from the current level. 

For both Dollar General and Dollar Tree, McShane does not see Walmart’s e-commerce game getting in the way of market share for the steep discounters. The big-box players are looking to capture the bulk purchase. Customers need to pay about $30 per basket to order online. For Dollar General and Dollar Tree, the average basket size is about $8 to $13, with the average item costing between $1 and $13. 

For Dollar Tree specifically, the stock has been out of favor and that may be the perfect time to buy it. It’s down 9.6% for the year. And it’s been treated by the market as a riskier play. It went down harder than the broader market on the way down and has only recovered 29% from its 2020 low, compared to the S&P 500’s 34% bounce. Dollar Tree is now trading at roughly 18 times 2020 earnings, in line with its recent average, but well below its recent high of 23 times. 

Structural concerns have weighed on the stock. Its recent earnings have shown low single digits same-store-sales growth and pressured margins, mostly on the back of a hurting Family Dollar segment, which represents about 46% of annual revenue. Family Dollar has’t gotten much traction with customers recently. 

Some, including management, say the shortened holiday season hurt its last earnings report. But sales growth has been hard to come by and the company's operating margin has shrunk from 10% over more than a year. Analysts polled by FactSet are looking for 2.8% same-store-sales growth for the next year, just above 2% for the next several years and an operating margin of roughly 6% for 2020. That compares to Dollar General’s expected 5% expected same-store-sales growth this year and plus-3% growth for the medium-term future. The much larger and more scaled Dollar General is looking for an operating margin of around 8.5% this year. 

On margins, Dollar Tree management has said recently it aims to sell more discretionary goods this year, which are usually at higher price points, which supports margins. Those include summer or cooking-related goods. If Dollar Tree can reach these financial goals, the valuation could certainly expand. Plus, calendar  year 2021 earnings are expected to grow 14%, so excluding further deterioration in the valuation or the near-term earnings outlook, the stock could move up solidly this year. 

The big concern for Dollar General: execution. That hasn’t been consistent of late. 

The big concern for both companies: the economy may exhibit a recovery somewhere in line with what the market is pricing in. The “trade-down” in retail McShane looks for may not pan out. Evidence that state reopenings are successful and that stimulus has helped the consumer get through layoffs is emerging. 

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