EUR 850.00 For Business Accounts Only

Morningstar | On-Track End to Fiscal 2018 Leaves Our Outlook Intact for Dollar Tree; Shares Somewhat Rich

After no-moat Dollar Tree reported on-track fiscal 2018 results, we do not plan to make a large change to our $89 per share valuation. Our long-term view still calls for mid-single-digit yearly top-line expansion against high-single-digit adjusted operating margins over the next decade.

Dollar Tree saw $5.45 in adjusted diluted EPS on $22.8 billion in sales (in line with our targets), capped by fourth-quarter same-store sales growth of 3.2% and 1.4% for the namesake and Family Dollar banners, respectively. While management set its fiscal 2019 adjusted EPS guidance below our pre-announcement expectations ($5.16 to $5.56 adjusted for discrete costs, versus our $5.77 mark), we believe the discrepancy is due to tariff assumptions (guidance incorporates a 25% Section 301 tariff, which we do not) and timing. Leadership indicated it expects adjusted EPS to grow 14%-18% in fiscal 2020, which is near our mark if our assumed share buybacks are excluded. This suggests a more conservative cadence for Family Dollar's turnaround, which management expects to show marked signs of improvement in fiscal 2019's second half.

While Family Dollar continues to struggle (leading to a $2.7 billion impairment charge), management plans to accelerate its turnaround effort, boosting the pace of store renovations that it indicates have resulted in low-double-digit sales acceleration. This is inconsistent with activist Starboard's calls to explore strategic alternatives for the struggling banner, which we believe could refocus resources on the better-positioned Dollar Tree banner in the event of a divestiture. However, management is responding more favorably to the fund's calls for a multi-price approach at Dollar Tree, announcing it will test such a change at select stores. We applaud the conservative approach, as we remain concerned that a broader assortment could dilute Dollar Tree's value proposition and differentiation, exposing it further to an intensely competitive retail landscape.

While Dollar Tree has resisted Starboard's push for board representation and exploration of strategic alternatives for Family Dollar, it did announce the appointment of Carrie Wheeler, formerly head of TPG's consumer and retail large cap private equity operation, as its thirteenth board member. We view the move favorably and expect her skills will add to the roster of expertise available for the firm to call upon while boosting accountability. The change should not, however, alter our standard stewardship rating for the firm.

The company announced its real estate intentions for both banners. For Dollar Tree, the firm plans 350 new Dollar Tree stores, plus an additional 200 stores that are to be rebranded from Family Dollar. The rebanners come alongside 1,000 planned renovations at Family Dollar, 200 new stores, and 390 closures. The targets are not far from our expectations, and come alongside continued expenditures to add frozen and refrigerated capabilities to both chains and expand the enterprise's distribution center footprint. We suspect it will take time to fully optimize Family Dollar's network, and that the need to keep both banners' stores strong will keep overall capital expenditures at around 3.5% of sales long term, near fiscal 2018's 3.6% and above the firm's 2.9% average from fiscal 2015-17.