Divestiture And Multi-Price Expansion Will Transform Operations

Key Takeaways

• Divesting Family Dollar enables Dollar Tree to focus on its brand, improving financial health and operational efficiency, boosting margins and earnings.
  
• Expanding multi-price format stores and operational improvements are anticipated to enhance sales, stabilize margins, and potentially increase shareholder returns.
  
• Tariffs and transitional costs may pressure Dollar Tree's margins, while increased expenses and supply chain disruptions could challenge earnings growth.

Catalysts

Operates retail discount stores under the Dollar Tree and Dollar Tree Canada brands in the United States and Canada.

• The planned sale of Family Dollar is expected to provide Dollar Tree with an $800 million cash inflow, allowing the company to focus solely on the Dollar Tree brand and improve its financial health and operational focus, positively impacting both net margins and earnings.
  
• The expansion of Dollar Tree's multi-price format stores, projected to reach approximately 5,200 stores by end 2025, is anticipated to enhance sales productivity and revenue, with current 3.0 format stores already showing a significant uplift in traffic and ticket sales.
  
• Efforts to mitigate tariff impacts through supplier negotiations and potential price adjustments, as well as the diversification of sourcing strategies, are expected to stabilize or improve gross margins despite potential cost pressures from tariffs.
  
• The emphasis on operational improvements and enhanced store standards, including investments in store payroll and infrastructure, aligns with the strategy to drive sales growth and profitability, contributing positively to both revenue and net margin expansion.
  
• The anticipated increase in cash flow from the Family Dollar transaction, alongside a strong balance sheet and share repurchase plans, positions Dollar Tree to potentially enhance earnings per share through strategic capital allocation and shareholder returns.

Dollar Tree Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more optimistic perspective on Dollar Tree compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming Dollar Tree's revenue will grow by 7.6% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 5.9% today to 6.8% in 3 years time.
• The bullish analysts expect earnings to reach $1.5 billion (and earnings per share of $7.05) by about April 2028, up from $1.0 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 16.8x on those 2028 earnings, up from 14.8x today. This future PE is lower than the current PE for the US Consumer Retailing industry at 24.0x.
• Analysts expect the number of shares outstanding to grow by 0.06% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.02%, as per the Simply Wall St company report.

Dollar Tree Future Earnings Per Share Growth

Risks

• The potential imposition of new tariffs, especially the second round with 10% on goods from China and 25% from Canada and Mexico, introduces significant cost uncertainty, which could negatively impact profit margins.
  
• The separation and sale of Family Dollar entails transitional costs and a shared services burden that may pressure Dollar Tree's net margins and operating efficiency in the short term as they become standalone.
  
• The dependency on mitigating tariffs through tactics like price adjustments and supplier negotiations means any failure in these strategies could decrease gross margins.
  
• An increase in SG&A expenses, driven by IT investments and other corporate costs, could result in operational leverage challenges, affecting the overall earnings growth.
  
• The volatile economic environment, including shifts in sourcing strategies and external supply chain disruptions, could impact inventory costs and result in revenue fluctuations.

Valuation

• The assumed bullish price target for Dollar Tree is $94.24, which represents one standard deviation above the consensus price target of $83.71. This valuation is based on what can be assumed as the expectations of Dollar Tree's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $103.22, and the most bearish reporting a price target of just $70.0.
• In order for you to agree with the bullish analysts, you'd need to believe that by 2028, revenues will be $21.9 billion, earnings will come to $1.5 billion, and it would be trading on a PE ratio of 16.8x, assuming you use a discount rate of 7.0%.
• Given the current share price of $71.8, the bullish analyst price target of $94.24 is 23.8% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.