As earnings approach on Aug. 21, investors holding stock in Dollar Tree (NASDAQ:DLTR) are probably trying to figure out what to do with the retailer's shares. After announcing an agreement to buy Family Dollar (NYSE:FDO) in a deal valued at $8.5 billion (when announced), it's clear that management plans to grow the enterprise, but with such high growth expectations for the quarter, combined with the business trading at 18 times forward earnings, should shareholders be more cautious?
Shooting for the moon
For the quarter, Dollar Tree is expected to report revenue of $2.01 billion. If this forecast provided by analysts is accurate, it will represent an almost 9% jump in sales over the $1.85 billion management reported during the second quarter of its 2014 fiscal year. With its store count having shot up 31% over the past five years from 3,806 locations to 4,992, combined with its aggregate comparable store sales growth hitting 28%, it's almost certain that any sort of growth in sales will have been accomplished through a combination of increased store count and comparable store sales improvements.
|Earnings per Share||$0.56||$0.64|
From a profit perspective, expectations are even higher. For the quarter, analysts anticipate Dollar Tree's earnings per share to come in at $0.64. If this comes to fruition, it will represent a 14% jump in profits year-over-year from the $0.56 seen in its 2014 fiscal year and will be attributable to sales growth, a reduction in selling, general and administrative expenses (this metric has fallen from 25.7% of sales in 2010 to 23.2% in 2014), and a reduction in share count.
Will its buyout of Family Dollar be a boon for business?
Moving forward, one of the big hopes is that Dollar Tree's acquisition of Family Dollar will help the company more effectively compete with rival Dollar General (NYSE:DG). With sales per square foot of $220, up 13% from $195 per square foot five years earlier, Dollar General is the strongest of these three discount chains. Family Dollar's sales per square foot, in comparison, stands at only $189, while Dollar Tree's $187 lands it in last place.
More likely than not, it's not the extra $2 per square foot that Dollar Tree is hoping to grab. Rather, it's the ability to grow sales per square foot at a faster pace. Over the past five years, Dollar Tree's metric rose just 12% from a base of $167, while Family Dollar blew away the competition with a 20% jump in revenue for every square foot.
By tapping into the source of this growth, the company should be able to increase its profitability, but with its core business model centered around products selling for $1 or less vs. its peers' emphasis on discount items that may or may not sell for more than $1, there's no guarantee that any meaningful synergies will develop. If not, the best it can hope for is to piggyback off of some of Family Dollar's growth from its own stores.
Currently, Mr. Market has high expectations for Dollar Tree. While the company has shown growth in the past, the fact that its sales per square foot have increased at a slower pace than that of its peers implies that the retailer isn't without limitations. In the long run, the real endgame appears to be to what extent the corporation can use Family Dollar's strong sales growth on a per-square foot basis to increase its own revenue.
For investors who believe that management has the tools necessary to accomplish this goal, Dollar Tree could make a great pick, irrespective of what its earnings and revenue turn out to be. But, for those who don't believe the company can achieve faster growth post-acquisition, its pricey stock and the high expectations analysts have for it might serve as a cautionary note moving forward.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.