Dollar Tree's Strong Fourth Quarter Quells Fears In The Sector

| About: Dollar Tree, (DLTR)

Wednesday morning, discount retailer Dollar Tree (NASDAQ:DLTR) announced solid fourth quarter results. Revenue jumped 15% year-over-year to $2.3 billion, slightly above consensus estimates. Earnings also exceeded consensus expectations, up 26% year-over-year to $1.01 per share.

Same-store sales at the chain increased 2.4% during the quarter, reflecting broad-based geographic and category space. Not surprisingly, comps accelerated in December as the firm's value proposition drove holiday shoppers into the store. The firm also expanded its frozen goods selection, which was put into 329 new stores in 2012. Management indicated that the company plans on equipping more stores with refrigeration capabilities, which could add incremental higher-margin sales.

Gross margins were 10 basis points higher year-over-year during the fourth quarter at 37.9%. Due to the value-proposition nature of the business, we don't see much near-term gross margin upside. However, since the business is highly-dependent on product mix, we could see more merchandise move if consumer sentiment increases. With low-end consumers in particular getting hit hardest by the end of the Payroll Tax holiday, we don't think any significant change in gross margins is in store for 2013.

Sales growth resulted in 50 basis points of SG&A leverage, lowering the expense to 21.7% of sales. This resulted in an operating margin of 16.2%, 70 basis points higher than during the fourth quarter of 2011. Operating margins for the full-year were 60 basis points higher at 12.4%. Unlike some of its peers, Dollar Tree won't be adding lower-margin tobacco to its sales mix in 2013, so we anticipate the profit mix will remain strong.

Though the laundry list of negativity that could weigh on consumption (including the budget sequester, end of the payroll tax holiday, tight job market, and tempered wage growth) provide plenty of reason to be cautious on the consumer in 2013. CEO Bob Sasser provided some interesting counter-analysis that also summarizes why the dollar stores like Family Dollar (NYSE:FDO), Dollar General (NYSE:DG), and Dollar Tree have held up so well during the past few years, saying:

"Look, the consumer is under pressure. Burdened and concerned is the way we sort of characterize the consumer right now. They're facing not only higher payroll taxes but rising gas prices. And with the tax refunds being delayed, they really are under pressure. Overall, less money to spend and you add to that job concerns and uncertainty that everybody sees out there right now. But at Dollar Tree, we think of ourselves as part of the solution. We're seeing the effect on the consumer. But we think we're part of the solution and a destination for a cash-strapped customer that's trying to balance their budget. We have all the things that you need. Over half of what we sell now, 50.1%, are products that are needed most often and must-haves in everyday life, high value and they're only $1. And we're -- when our customers are in the store, they can still splurge at Dollar Tree. On the discretionary products, yes, you can afford it at Dollar Tree. It maybe discretionary, but it's only $1 also. So we believe as we've said for years, we are right for all time. We believe we're more relevant today with the consumer under pressure than we've ever been. And we think that's going to continue for a few years, several years."

In fact, we continue to believe that the dollar stores will exhibit defensive qualities if consumers shift to more cautious spending patterns. Unfortunately for investors, the sector performed quite well through the course of both 2010 and 2011, so the market is already fairly valuing their defensive nature and strong forward-looking fundamentals.

Looking ahead, Dollar Tree gave solid guidance for 2013, anticipating low-single-digit same-store sales growth, driving total sales to $7.79-$7.97 billion and earnings per share of $2.54-$2.74. Management also indicated that it will use excess cash to repurchase stock, so there remains further upside to the bottom-line range, in our view. Regardless, shares look to be fairly priced at this time, and we'd like to see a material pullback before the company may warrant consideration for the portfolio of our Best Ideas Newsletter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.