Dollar Tree (NASDAQ:DLTR) can Reignite Earnings Growth with Higher Price Points and Share Buyback

October 04, 2021
  •  Updated
December 10, 2021
Source: Shutterstock

Last week the share price of Dollar Tree, Inc . ( NASDAQ:DLTR ) jumped 16% after the company announced an additional share buyback, and that it will begin to sell higher priced items. The sudden increase in the share price may seem like an overreaction to the news - but both announcements could actually make a big difference to Dollar Tree’s earnings growth outlook.

Retailers like Dollar Tree have been more immune to the effects of e-commerce than high end retailers. But inflation is a big problem when you limit your upside with a one-dollar price point. The chart below illustrates that analysts have been expecting earnings to remain flat over the next few years, despite rising revenue. This would result from rising costs, without a corresponding increase in the price charge for each item.

NasdaqGS:DLTR Earnings and Revenue Growth October 5th 2021
NasdaqGS:DLTR Earnings and Revenue Growth October 5th 2021

Dollar Tree is in the fortunate position of having much stronger margins than most retailers. The company manages a gross margin of 31% and a net margin of nearly 6%. By contrast, Walmart ( NYSE:WMT ) has a gross margin of 25% and a net margin below 1%. Good margins are great when it comes to profitability but don’t help with growth, unless there are opportunities to expand the company’s footprint.

Improving Earnings Growth

Dollar Tree is now using two other options it has to increase earnings growth:

It plans to begin adding new price points above $1 across all Dollar Tree Plus stores . It has already tested the concept at some stores, and will now implement the additional price points at all Dollar Tree Plus stores and begin testing new price points at legacy stores. This will allow the company to increase the range of products it can sell as well as the margin on each product.

Dollar Tree has also announced that it will increase its share buyback program by $1.05 billion to an aggregate amount of $2.5 billion . The initial buyback program was announced in March this year. This means the company can now buy back as much as 25 million shares, or about 10% of the outstanding shares. The average daily volume is around 3.2 million shares. By reducing the share count, earnings per share will rise as long as net income doesn't fall.

Dollar Tree’s Valuation

Our estimate of Dollar Tree’s valuation, which is based on analyst estimates, is $151.46 - more on this calculation here . This implies the stock is still trading at a 35% discount after last week’s rally. While the stock price appears reasonable, investors are often reluctant to invest in companies with limited growth prospects. This is illustrated by the stock’s price-to-earnings ratio (or "P/E'") of 14.9X. This is substantially lower than the broader market’s P/E ratio of 17.8X - but not surprising as Dollar Tree is expected to grow earnings at a slower rate than the market.

Raising prices and buying back shares should allow the company to grow earnings, and lead to a higher P/E ratio in the future.

Is there an opportunity in Dollar Tree?

Just how much these initiatives will increase earnings growth remains to be seen - Which is probably why analysts have yet to update their forecasts. But it does provide a potential catalyst for an improved outlook, which could lead to a more permanent re-rating for the stock. The share buyback may also provide some support for the stock price,

This is just one aspect of Dollar Tree that potential investors should be aware of. You can track the growth outlook as seen by analysts, as well as other key factors on our free analysis page for Dollar Tree .

If you are no longer interested in Dollar Tree, you can use our free platform to see our list of over 50 other stocks with a high growth potential.

Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

Valuation is complex, but we're helping make it simple.

Find out whether Dollar Tree is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis