Dollar Tree: Shares Do Not Offer Same Value As Merchandise Yet

| About: Dollar Tree, (DLTR)

Shares of Dollar Tree (DLTR), the operator of discount merchandise stores, fell 3.5% over the past week. The company known from its brands, Dollar Tree, Deal $, Dollar Giant and Dollar Bills, reported its second quarter results on Thursday. Investors were slightly disappointed with the results as they came in line with analysts expectations.

Second Quarter Results

Dollar Tree reported second quarter revenues of $1.70 billion, up 10.5% compared to last year. Comparable sales, for the store which sells merchandise for $1 or loss, grew 4.5% over the quarter. Diluted earnings per share rose 30.8% to $0.51, in line with analysts expectations.

The company boosted operating margins by 80 basis points to 10.8%. The margin increase is entirely attributable to a 80 basis points reduction in selling, general and administrative expenses. Compensation and healthcare costs fell as a percentage of revenues amidst improvements in productivity.

During the quarter, the company repurchased 1.6 million shares, for a value of $81 million. The company has $1.1 billion remaining under its current share repurchase authorization.

Dollar Tree opened 77 new stores during the quarter and closed 5 stores, resulting in a store count of 4,523 by quarter's end. Total retail footage grew 7.1% to 39.2 million square feet. The company still sees plenty of growth potential. Dollar Tree estimates it could operate 7,000 stores in the U.S., and another 1,000 in Canada.

CEO Bob Sasser commented on the results:

"I am pleased with our second quarter performance. Dollar Tree continues to deliver consistently strong sales and earnings. I am particularly proud of the increases in operating margin and inventory turns. We remain focused on providing great values for our customers and superior returns for our shareholders."

Outlook

For the third quarter of 2012, Dollar Tree anticipates sales at $1.71-$1.75 billion, driven by low-to-mid single digit comparable sales growth. Diluted earnings per share are estimated at $0.47-$0.51.

For the full year of 2012, Dollar Tree anticipates sales of $7.36-$7.45 billion. Diluted earnings per share are expected to come in between $2.45-$2.54. The fact that 2012 has 53 weeks, boosts annual revenues by an estimated $120-$130 million, and earnings by $0.07-$0.08 per diluted share.

Valuation

Dollar Tree ended its second quarter with $380 million in cash and equivalents. The company operates with short and long term debt of $264 million, resulting in a net cash position of $116 million.

For the first six months of 2012, the company generated revenues of $3.43 billion. It reported net income of $235 million, or $1.01 per diluted share. At this pace, the company is on track to report annual revenues of $7.4 billion, according to the company's own guidance. Annual net earnings are expected to come in at almost $600 million, or $2.50 per share.

Based on Friday's close around $49 per share, Dollar Tree is valued at $11.2 billion, valuing the operating assets at $11 billion. The market values the firm at 1.5 times annual revenues, and 20 times annual earnings.

Competitor Family Dollar Stores (FDO) trades at 0.9 times annual revenues and Dollar General Corp (DG) at 1.2 times annual revenues. These competitors trade at 18 and 21 times trailing annual earnings, respectively. Currently, Dollar Tree does not pay a dividend.

Investment Thesis

Year to date, shares of Dollar Tree trade with gains of 18%. Shares steadily rose from levels of low forties at the start of the year, to peak at $57 in June. From that point in time, shares have seen a correction of 15%, as investors became wary of premium valuation for discount merchandise stores.

Over the past five years, shares of Dollar Tree have returned over 300%. The "squeezed" middle class in the U.S. resulted in a booming business for the discount merchandise retailer. Revenues rose from $4.6 billion in 2008, to an estimated $7.4 billion in 2012. Net income rose even faster, from $230 million in 2008, to an estimated $600 million by 2012. As the company repurchased about 10% of its shares outstanding over that period of time, earnings per share tripled from $0.84 in 2008, to an estimated $2.50 in 2012.

The long term fundamentals for the business remain strong with the U.S. middle class continuously being squeezed by high unemployment, stagnating wages and rising fuel prices. Despite a 15% correction, I would like to see shares correcting further towards the $40-$45 region, before considering initiating a long position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.