While S&P (NYSEARCA:SPY) is hovering around its all-time highs, Dollar Tree (NASDAQ:DLTR) has lost 22% since it posted its all-time high last summer. Although its underperformance is pronounced, it is still trading at a rich valuation, with a trailing P/E ratio = 21. Therefore, the future returns of the stock are highly uncertain at the moment. Nevertheless, investors can earn an approximate 4.0% annual yield by purchasing the 3-year bonds of the company. This almost risk-free yield can hardly be found elsewhere in the current environment of near record-low interest rates and should be particularly attractive to retirees, who seek a decent yield with minimal risk.
More specifically, the 5.25% bonds of Dollar Tree that expire in March-2020 currently trade around 103.5. Therefore, they offer an approximate 4.0% annualized yield for the 3-year period until their maturation. This is a pronouncedly high yield for a 3-year bond of a company with a very solid business model, particularly given that the company is still in a clear growth trajectory.
First of all, the analysts expect the company to grow its earnings per share by 21% next year, from $3.74 to $4.52. In addition, while the net debt (as per Buffett, net debt = total liabilities - cash - receivables) seems remarkably high at $10.4B, investors should realize that this debt has fully resulted from the acquisition of Family Dollar one and a half year ago. Nevertheless, the current ratio of 2.0 is very healthy. In addition, the company does not spend any money on dividends and share repurchases and thus uses all its earnings to reduce its debt load. As the earnings and the free cash flow of the last 12 months are about $0.8B and are expected to keep growing for the foreseeable future, they are clearly sufficient for the company to keep servicing its debt without any problems.
Moreover, Dollar Tree has exhibited markedly consistent performance in the last few years, without any signs for a black swan going forward. To be sure, its same-store sales have exhibited growth in the range of 0.7%-2.3% during the last 4 quarters. This reliable growth does not even signal decreasing earnings going forward, let alone a default in the next 3 years.
Part of the relatively high yield of the bonds of Dollar Tree may be attributed to the major threat of almost all retailers, namely Amazon (NASDAQ:AMZN). However, while Amazon has exerted great pressure on many retailers, dollar stores tend to attract different shoppers from the retailers that have been suffering from Amazon, such as Gap (NYSE:GPS) and Macy's (NYSE:M). Therefore, it seems that the bonds of Dollar Tree have been indiscriminately punished due to the threat that Amazon poses to most retailers.
Moody's recently included Dollar Tree in its top picks for this year, as the firm believes that consumers look to save money on multiple fronts. Deutsche Bank issued an equally bullish report for the stock a few months ago. When a stock is considered to have such promising growth prospects, its bonds can certainly be viewed as essentially risk-free. Therefore, as the bonds of Dollar Tree offer a much higher yield than the other risk-free 3-year bonds in the market, investors can take advantage of this divergence and earn a decent yield with the bond portion of their portfolio. This is particularly true for retirees, who need an essentially risk-free yield that is as high as possible.
To sum up, Dollar Tree currently has a high debt load, which has resulted from the acquisition of Family Dollar. In addition, the relatively high yield of its bonds may be partly attributed to the Amazon effect. However, dollar stores are hardly affected by the retail giant. Moreover, Dollar Tree does not spend any money on dividends and share repurchases and hence it is reducing its debt at full throttle, as its free cash flows are ample and keep growing. Therefore, given the current environment of almost record-low yields, the 3-year yield of 4.0% is remarkably attractive.
Disclosure: I/we 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.
Additional disclosure: I may purchase DLTR bonds over the next 72 hours.