DLTR - Dollar Tree Q1 Earnings Overreaction Sets Up A Trade

2023-05-25 11:00:14 ET

Summary

• Shares of Dollar Tree, Inc. are getting nailed on Q1 2023 earnings.
• A retailer like this should do well in a recession as consumers trade down.
• The company tightened its fiscal 2023 sales outlook range to $30 billion to $30.5 billion vs. consensus of $30.31 billion.
• The drop takes Dollar Tree, Inc. stock to levels we consider appropriate to initiate a position, as the discount retailer should perform in a mild recession.

Dollar Tree, Inc. ( DLTR ) stock has a bit of a stretched valuation after recent runs with the market. However, the stock is pulling back today on Q1 earnings , which we will cover here, and we believe a simple trade can be made now. We set the trade up to allow you to scale in to build a position that we think would be a several-quarter hold. In the event of a mild recession, we see Dollar Tree doing well as shoppers trade down some from more higher-end or even big box stores. Dollar Tree, Inc. also has a sizable buyback in place and now would be a good time to step in and start retiring shares as they are down 15% on the earnings. Let us lay out our trade then discuss earnings.

The play

Target entry 1: $130-$131 (25% of position)

Target entry 2: $125-$136 (35% of position)

Target entry 3: $120-$121 (40% of position)

Stop loss: $105

Target exit: $150.

Options considerations: Put selling can work to define entry if you are laying out enough coin to purchase 100 share blocks in conjunction with common stock purchasing. We also think call options can work here, particularly if/when the stock falls a bit further. Guidance on exact strikes for trades are reserved for members of our Investing Group.

Note this sample trade along with spelled out options are the types of trades we outline, with high conviction, at BAD BEAT Investing.

Discussion

First, we think Dollar Tree, Inc. stock is overreacting a little on this. Valuation was a bit stretched, however, so a bit of a correction is likely warranted. That sets up a trading opportunity, in our opinion. Here was a look at the valuation before the drop:

With this decline today, these figures will improve, and valuation will look a bit better. However, Dollar Tree, Inc. stock is not "cheap," even at $130 a share. But it's attractive to start entry.

This company has really cleaned house in recent years. First it was price hikes at Dollar Tree, then it was inventory management, and then it was overhauling the Family Dollar stores. The company continues to execute on its plan to fundamentally transform and improve operating performance of its shops long term. The company has an investor's conference in June where it will update on its plans, and that could be a catalyst to drive the stock higher.

The company is seeing continued sales increases. Sales increased 6.1% to $7.32 billion versus last year. This comes as same-store sales increased 4.8%. Comparable same-store sales are a key figure, and seeing them this positive is a good sign. Dollar Tree same-store sales were up 3.4%. This was due to a 5.5% increase in traffic, yet was offset by a 2.1% decline in average ticket price. Family Dollar’s 6.6% same-store sales increase was due to a 4.3% increase in traffic along with a 2.2% increase in average ticket price.

Gross profit decreased, but last year was the first year with the $1.25 price point at Dollar Tree stores. Since then, inflationary forces have weighed. Since Dollar Tree holds its pricing firm, it cannot pass its increased costs on to the consumer. However, an increase to $1.50 in the future could certainly be in the cards.

That said, Dollar Tree, Inc. gross profit dipped 4.7% to $2.23 billion and gross margin declined 340 basis points to 30.5% compared to last year. Unfavorable sales mix and shrink weighed, as did higher costs of product. However, it was partially offset by lower freight costs.

Factoring in operating expenses, we saw operating income was $419.7 million and operating margin was 5.7%. Adjusted operating income was $449.7 million and adjusted operating margin was 6.1%, while net income was $299.0 million, or $1.47 adjusted.

Looking ahead, the guidance came off as disappointing. The company sees net sales for full-year fiscal 2023 to be $30.0 billion to $30.5 billion, consensus was at $30.31 billion. This view comes on expectations of low- to mid-single-digit comparable store sales increase for the year, comprised of a low- to mid-single-digit increase in the Dollar Tree segment and a mid-single-digit increase in the Family Dollar stores.

Based on our expectation for Dollar Tree, Inc. SG&A expense to be 23-25% of sales, with comparable operating expenses to last year or a low-single-digit increase, without factoring in more repurchases, we anticipate EPS of $6.50-$6.80. That puts Dollar Tree, Inc. valuation at about 19.5X FWD EPS, a level which has historically been a good buy in this name. The valuation improves on the way down as you build a position in Dollar Tree, Inc. stock.

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