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Morningstar | While Competition Is Fierce, Dollar Tree Can Boost Margins as Family Dollar Improves

While Dollar Tree's namesake banner has a long history of strong performance, enabled by its differentiated value proposition, its Family Dollar unit has struggled to generate top-line and profitability growth since it was acquired in 2015. Although we suspect the Dollar Tree banner is better positioned, we do not believe the aggregated firm benefits from a durable competitive advantage, as ongoing competitive pressure in a fast-changing retail environment amid minimal switching costs limits results.Accounting for around half of sales, the Dollar Tree banner's wide assortment of products at a fixed $1 price point has appealed to customers, with the stores drawing a broad range of low-to-middle-income consumers. We believe the concept still has room to grow and anticipate the firm should be able to expand in new markets while also increasing density. The chain's fast-changing assortment creates a treasure hunt experience that has a history of drawing customers (posting 3% same-store sales on average over the past five years and 4% over the past decade) and has been difficult for online retailers to match. With basket sizes small and the average transaction resulting in a modest bill, we consider the segment relatively well insulated against the ever-present digital threat.Prospects at Family Dollar are murkier, with the chain continuing to struggle since its acquisition. Evenly distributed between urban and rural areas, we believe the chain's presence in cities is especially susceptible to competitive pressures from a wide range of convenience stores, mass merchandisers, and grocers. While its blend of low prices and convenient locations carries appeal, particularly among customers that do not have nearby alternatives, we expect that the benefits of operational improvements and tighter integration with Dollar Tree will largely be offset by competitive strain.Despite the headwinds, we expect both chains can deliver long-term top-line and margin growth in aggregate, capitalizing on consumers' desire for convenience and value to drive results even as the landscape becomes more challenging.