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Summary

  • Dollarama continues to show good management of its inventory.
  • Dollarama has the capital structure to expand aggressively across Canada.
  • Despite the recent stock price growth, the P/E ratio still shows the stock is still valued at historic averages.
  • A weaker Canadian dollar will hurt sales.
  • Food and retail business becoming increasingly competitive.

Dollarama (OTC:DLMAF) revealed its earnings in April, and once again, Dollarama showed growing revenues, and increased the store count to over 850 stores. To get a sense of where Dollarama is heading, we need to look at the highlights that occurred in the past 12 months, and then analyze where Dollarama is likely to go in the future 12 months.

Past Highlights: Efficient Supply Chain

From an inventory standpoint, the total inventory to current assets sits at 79% in 2013, down from 83% in 2012. Dollarama sources many of its inventories internationally and the weakening of the Canadian dollar should be hurting its bottom line. Instead, the inventory levels are dropping relative to its assets. This means that Dollarama is selling more of its inventory given a climate of higher costs. Inventory is recorded at cost and recent purchases aboard should have shown higher inventory levels in its financial statements. Part of the explanation for its efficient supply chain can be answered by its quest for constant productivity improvements. Recently, it has reduced the hours employees spent counting inventory by using a new point-of-sale scanning system. This has resulted in about 10% savings of costs. Also, Dollarama has currency hedges in place for at least 6 months. This should provide some short term relief on its bottom line.

Dollarama Still Has The Financial Capacity to Grow

The Dollar business segment in Canada is largely fragmented and this offers opportunities for companies to grow. Dollar Tree (NASDAQ:DLTR) is one such company that has expanded into Canada in 2010. Dollar Tree has become the second largest Dollar store operator in Canada with 129 stores. "Dollar Store and More" is close behind with 120 stores. Dollarama has 874 stores, with plans to aggressively grow even further. Its plans are to open 80 stores in 2014 and another 80 in 2015.

To help fund this growth, I anticipate Dollarama to use more of its debt like in previous years. The long term debt to equity is at 37.84% from 22.49% a year ago. These figures still looks good when it is compared to the competition like Dollar Tree. Dollar Tree has a higher debt to equity ratio than Dollarama, at 41.79%. Also, with Dollar Tree's presence in the U.S. as well, it has to divide its resources between expanding into Canada and to the U.S.

The recent dividend hike should not put a damper on its growth prospects. On an annual basis, Dollarama is obligated to pay out $44,466,500 in dividends a year. At the end of Q4-2013, Dollarama has current ratio of 2.78. This gives the company $458,900,000 in current assets and $164,821,000 in current liabilities. This means that Dollarama has ample funds to continue its payout and pursue a strategy of growth. It is rare in most industries to see a company that is both growing as well as paying a steady dividend.

P/E Ratio Slightly Above Historic Average

In looking at the P/E ratio, the current price sits at around $88.54, and this gives it a P/E ratio of 25.24 times its earnings. At this price it is trading slightly above is P/E ratio of 22 to 23 times its earnings (22.74 in 2012 and 22.02 in 2011). This could signal investor's faith in the company's growth prospects since the last several quarters the company has been consistently beating analyst sales projections. However, it will take time for Dollarama to increasing its earnings again before the P/E ratio can stabilize back to its 22 to 23 range.

Currency Fluctuations: A Snag in the Engines

One of the snags that can hit its engine growth is the weakening of Canadian dollar. Part of Dollarama's successful run was its ability to source products around the world at a favourable exchange rate. A higher Canadian Dollar allowed Dollarama to receive favourable pricing. With the Dollar weakening and its expectation that it will weaken further, Dollarama's profits could be undermined. Recently, Dollarama has decided not to hike prices even when import prices for building materials rose 12.9%.

New Competitive Threats

In the last five years, retail competition has become fiercer. Target (NYSE:TGT) has entered Canada with the opening of 125 stores in 2013. Wal-Mart (NYSE:WMT) has renewed its drive to lower prices through a supplier agreement with Wild Oats. Sobey's had asked for a 1% retroactive price cut from its suppliers. Dollarama already anticipates lower gross margins next year from 36% to 37%. The latest Q4 figures showed margins were at 38.4%.

Conclusion

Overall, Dollarama has a great track record for maintaining growth. It has rewarded investors well in each successive year. Its management of inventory is superb. In a weakening Canadian dollar environment, Dollarama can still lower inventory levels, and this speaks volumes to the efficiency of its supply chain. The fundamentals of the company show the firm is leveraging more of its debt to fund future growth, and the capital structure has that ability to take on more debt. The P/E ratio is showing the company is still within a reasonable price range. The large lift in earnings this past year certainly warrants the large price jump. The headwinds facing Dollarama are a bit of a cause for concern however. The weakening Canadian dollar and the growing competition from its competitors do pose a threat. We are already seeing a weakening of Dollarama's sales figures. However, given Dollarama's track record and its responses to industry threats and internal weaknesses, I am confident Dollarama growth can be sustained.

Source: Dollarama Is Still An Attractive Buy