CA - Dollarama: How Much More Growth Can Investors Expect?

2023-08-31 09:50:52 ET

Summary

• Dollarama has experienced significant growth since its IPO in 2009, with shares up 2,703.06% and a strong track record of store expansion.
• The company's success can be attributed to opening new locations, consistent same-store sales increases, and successful share buybacks.
• Dollarama still has growth potential, with estimates of up to 2,000 stores by 2031 and opportunities for expansion in rural Canada and through its ownership of Dollar City.

Dollarama ( DOL:CA ) has been a fantastic stock since debuting on the Toronto Stock Exchange in 2009, fueling strong growth into substantial gains. But with more than 1,500 stores already open in Canada, is the dollar store concept too saturated to sustain much further growth?

(All figures in CAD unless indicated otherwise)

Introduction

Dollarama's history can be traced all the way back to 1992, when the Rossy family's chain of Quebec-based variety stores had an underperforming location. Instead of shutting it down, then-CEO Larry Rossy converted the store in Matane into a new type of store that would sell merchandise priced at a maximum of $1.

The idea was immediately a hit, and Rossy quickly started converting the company's other stores to dollar stores. He then started expanding the concept throughout Quebec and into neighboring New Brunswick. Growth was further buoyed by the acquisition of 60 locations in Ontario following a retail chain bankruptcy.

In 2004, the Rossy family made the decision to sell 80% of the rapidly growing chain to Bain Capital, knowing Bain would have the ability to keep funding the company's expansion plan. Larry Rossy stayed on as CEO and the family maintained a 20% position. Bain maintained its ownership stake until 2009, when the company debuted on the Toronto Stock Exchange.

It has been an absolutely stellar investment. Since the IPO, including reinvested dividends, Dollarama shares are up 2,703.06%, enough to turn an original $10,000 investment into something worth more than $280,000.

Post IPO success

At the time of its IPO, Dollarama had 585 stores and sales of just under $1.2B, which collectively generated approximately $160M in annual EBITDA. At the time of its IPO it had delivered excellent sales growth, but it was struggling to grow EBITDA.

Dollarama's success from its IPO through today can largely be attributed to three factors:

1. Success opening up new locations
2. Consistent same-store sales increases
3. One of Canada's most successful share buybacks

Let's start with store growth. A key part of Dollarama's business plan since its IPO has been to open new stores, which, over the course of more than a decade, has increased store count substantially. At the end of the company's most recent quarter, it has 1,507 stores in Canada . It also owns a 50.1% interest in Dollarcity, a Latin American dollar store chain with 448 stores spread across Colombia (267 locations), Guatemala (91 locations), El Salvador (66 locations), and Peru (24 locations).

It has been opening between 65 and 75 locations per year pretty consistently in Canada. Since 2015, store count at the end of each fiscal year has been:

• 2015: 955
• 2016: 1030 (+75 stores)
• 2017: 1095 (+65 stores)
• 2018: 1160 (+65 stores)
• 2019: 1225 (+65 stores)
• 2020: 1291 (+66 stores)
• 2021: 1356 (+65 stores)
• 2022: 1421 (+65 stores)
• 2023: 1486 (+65 stores)
• 2024: 1546-1556 (+60 to +70 stores)

As of April 30th, 2023, the end of Dollarama's fiscal 2024 first quarter, it had opened 21 new stores . Management projects 60 to 70 new stores to open in the current fiscal year.

Dollarama has also had success increasing same-store sales. Much of this has been from increasing the maximum retail price of items from a $1 maximum all the way up to $5 , a winning formula as consumers were happy to pay higher prices, further cementing the chain's value. It also helped the company pass through price increases to customers during 2022's high inflation environment.

Another reason for its same-store sales success comes from the chain's small stores, which are typically about 10,000 square feet. It carries a much smaller variety than a supermarket, leveraging suppliers against each other to secure the best deal.

Here's how it works, using dish soap as an example. Dollarama has a much smaller dish soap section compared to a supermarket, so it only needs to stock a few different varieties. It'll have a generic brand, of course, leaving even less shelf space for branded varieties. So it'll approach the top dish soap manufacturers with a deal -- if they want their dish soap in a Dollarama store, they'll play ball. It's a win-win, the soap manufacturers get their top selling SKUs in 1,500+ stores, Dollarama maintains their industry-leading 40%+ gross margins, and customers are happy because they can get that they perceive to be a good deal.

Finally, the last key to Dollarama's stellar total returns is the company's consistent share buyback. Since the end of fiscal 2013 -- when the buyback really took off -- the company has repurchased approximately 146 million shares, reducing the share count from 431M to 285M. Percentage wise, that's a reduction of approximately 33%.

While it's important to understand why a stock has been successful, ultimately successful investing requires us to look forward. Specifically, with Dollarama, that will come from continued growth. However, naysayers are quick to point out the company's stores are already quite saturated. How many stores can it continue to open? And, more importantly, can these stores perform as well as existing stores?

Let's examine a few different reasons why Dollarama still has growth potential, and attempt to estimate how many stores it could possibly open.

How many stores?

Let's look at a couple different perspectives to see how many more stores Dollarama could potentially open. We'll start with the company's estimates.

For years, Dollarama told investors it expected to cap out at around 1,700 stores. But, in 2021, the company increased that estimate , saying it saw potential for up to 2,000 stores by 2031 while being able to maintain its current capital payback period of approximately two years.

From the 2021 Annual Information Form:

Remember, by the end of fiscal 2024, Dollarama will have approximately 1,550 stores, assuming no major stumbles with its development program. To achieve that 2031 goal, this works out to a net gain of 450 stores over the course of seven years, or 64 stores per year. This is conveniently the same pace at which the company has opened stores since 2017.

2,000 stores by 2031 looks to be like a pretty achievable goal, but here's why it could end up being a little light.

Let's look at Dollarama's potential in a different way, using metric bulls have long used to argue Dollarama's growth potential, dollar stores per capita.

Essentially, the argument goes a little something like this. Led by Dollar General (NYSE: DG ) and Dollar Tree (NASDAQ: DLTR ), the dollar store concept in the United States is hugely popular. They're everywhere, from the largest cities to the smallest towns. And there are a lot of them. According to IBISWorld, there are 35,421 dollar stores in the United States .

There are approximately 340M people in the United States, which works out to one dollar store for every 9,500(ish) people.

Canada, meanwhile, is far less saturated with dollar stores. Data is tougher to find on the number of dollar stores in Canada, but we can estimate fairly easily since the market is dominated by only a few top players, which include:

• Dollarama (1,507 stores)
• Dollar Tree ( 228 stores )
• Great Canadian Dollar Store (115 stores)

The top three players combine for 1,850 stores. Combine that with independent stores and we'll estimate there are 2,000 dollar stores in Canada today.

Canada's population recently surpassed 40M people , with plans to add an additional 465,000 people in 2023, 485,000 in 2024, and 500,000 in 2025 . But we'll use 40M as a base.

This works out to one dollar store for every 20,000 people in Canada, or less than half as saturated as the United States. If Canada was able to support as many dollar stores as the United States, it would mean Canada has room in its market for an additional 2,000 stores today, plus an additional 50 stores per year based on population growth.

If we assume Canada welcomes 500,000 immigrants per year from 2023 to 2031 -- for a total of four million people -- and that the country can sustain as many dollar stores per capita as the United States, it works out to a market size of 4,400 stores by 2031. Dollarama plans to have 2,000 stores by 2031, and assuming the other chains maintain market share, we're well short of the 4,400 store saturation point. That bodes well for store openings after 2031.

One area Dollarama hasn't really tapped yet is rural Canada. It already has a strong presence in markets with approximately 10,000 people, but it hasn't really focused on communities with less than 5,000 people, mostly because it hasn't needed to. It's easy to see the potential there, and it has worked quite well for Dollar General in the United States.

Other growth avenues

The nice thing about Dollarama is it doesn't just need to open new stores in Canada to grow. It has a couple of other ways to increase the business over time that I'd like to touch on.

The first is its 50.1% ownership of Dollar City, which had 448 stores as of the end of fiscal 2023. Dollar City is growing rapidly, and has a target of 850 stores by 2029 . It is focused mostly on Colombia and Peru, which have a combined population of 86M, much greater than Canada.

There's also potential for Dollar City to expand into other LATAM markets, including Mexico, a market Dollar General has begun expanding into. Mexico is a lucrative prize because of its large population (125M+), its relatively prosperous economy (at least when compared to other LATAM markets), and its lack of domestic competition in the dollar store space. Although these advantages are offset somewhat by the nation's infamous organized crime troubles.

The point is Dollar City looks poised to grow for years to come, with multiple potential growth avenues.

The second way Dollarama can increase revenues is by growing same-store sales from its existing stores, something it has historically done much better than retailing peers like department stores or supermarkets. Here's a look at Dollarama's same-store sales growth since fiscal 2016.

• 2016: 7.3%
• 2017: 5.8%
• 2018: 5.2%
• 2019: 2.7%
• 2020: 4.3%
• 2021: 3.2%
• 2022: 1.7%
• 2023: 12.0%

These are encouraging numbers because the company's same-store sales have steadily crept higher even as it opens 65 new stores each year. New stores obviously aren't cannibalizing the existing ones. It also shows that the strategy of carrying higher priced items is working. And it continues to confirm one of the best parts of Dollarama's business model, where the company's stores are small enough that it can choose not to participate in hyper competitive categories.

The bottom line

With Dollarama shares currently trading hands at more than 27x forward analyst consensus earnings estimates, it's fairly obvious the market expects Dollarama to put up excellent growth numbers over the next few years. That expectation is priced into its valuation.

Dollarama has also fared much better than its U.S. counterparts over the last year, recently touching a 52-week high while both Dollar General and Dollar Tree shares have fallen pretty significantly from their recent highs. The market is worried about a possible recession impacting the U.S. consumer, but doesn't seem to be worried that a potential spillover into Canada could impact Dollarama.

It's fairly obvious why so many investors are bullish on Dollarama. It continues to open stores at a predictable clip. It has been successful increasing both total sales and the all-important same-store sales metric. And it has one of the market's best share buyback records, eliminating approximately a third of all shares since 2013.

Perhaps most importantly, it still has a long runway in Canada, with potential for hundreds of new stores (management's projection), or thousands of new stores (based on U.S. dollar store penetration) over the next decade. And that doesn't even include its stake in Dollar City, which continues to make impressive inroads in Latin America, or continued success in increasing same store sales.

The only issue this analyst sees is buying at today's prices, which are reflecting peak optimism. Personally, I'm waiting for a pullback before adding to my position.

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