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Morningstar | Continued Challenges at Family Dollar Weigh on Dollar Tree; Shares Attractive Despite Near-Term Woes

With narrow-moat Dollar Tree's Family Dollar unit still struggling, we anticipate cutting our $98 fair value estimate by a high-single-digit percentage in the wake of soft second-quarter earnings. While the namesake stores are performing well, posting 4% first-half same-store sales growth, the continued rehabilitation of Family Dollar will lead us to temper our near-term forecasts. Still, we expect the firm's competitive strength based on its brand intangible assets and a cost advantage will emerge as Family Dollar recovers, so we are leaving our long-term expectations (low- to mid-single-digit annual top-line expansion against high-single-digit adjusted operating margins over the next decade) broadly in place.

Through the first half, Dollar Tree posted 4.8% net sales growth against a 7.4% operating margin. The firm adjusted its sales and earnings per share guidance to $22.75 billion-$22.97 billion and $4.85-$5.05, respectively, versus its earlier $22.73 billion-$23.05 billion and $4.80-$5.10 indications and our $22.93 billion and $5.07 preannouncement targets.

Family Dollar (about half of sales) continued to struggle to generate traffic and profitability growth, posting a 0.5% same-store sales decline and 30 basis points of operating margin degradation through the first half. While retail results have generally been strong, we suspect the chain's greater focus on lower-income consumers and operational shortcomings kept it from capitalizing on the favorable environment for the rest of the sector. Given this and an ongoing need for store renovations, personnel investments, and escalating freight and labor costs, we suspect the chain's headwinds will persist in the near term. Still, we expect Dollar Tree should be able to rely on its namesake stores to deliver growth, as we think the combination of low-priced items and convenience will help protect the unit even as the digitization of retail sparks change industrywide.