This Market Darling Is Starting to Slow Down


With the economy starting to improve, you might think Dollar Tree's fortunes will reverse. The deep discounter provided unemployed and lower-income consumers a safe place in the storm, but with the economic weather clearing up, it would be reasonable to expect consumers to venture out again to higher-end retailers. However, that assumption would be wrong.

Dollar Tree recently announced record first-quarter earnings, with total sales up 8% and comparable-store sales up 2.1%, crushing the likes of big-box retailers like Safeway and Wal-Mart , which only reported a change in comparable-store sales of 1.5% and negative 1.2%, respectively.

Part of the reason behind Dollar Tree's record profits is that the company reached a record operating margin of 11.6%. Despite Dollar Tree's deep-discount business model, this margin is far higher than Safeway's, and is almost double that of even a premium-priced grocer like Whole Foods .

However, while Dollar Tree may have higher margins than Whole Foods, its sales growth is starting to lag. It's certainly beating low-cost competitors, but the bifurcating phenomenon seems to be fading. For a time, it seemed that the deep discounters and the high-end retailers were both doing extremely well, as customers either got poorer or richer and the middle thinned out. However, this quarter, Whole Foods reported nearly 7% same-store sales growth, and expects full-year earnings growth of up to 17%, while Dollar Tree issued guidance for just 2.8% growth at the top end of the range -- and the bottom end included the possibility of negative growth.

That may explain why Dollar Tree's stock has faltered over the last year. The company is doing well compared to competitors, but growth is starting to slow down, and the stock isn't particularly cheap. Safeway, for comparison, has had essentially flat sales for the last year, and operating margin was actually down this quarter, but small improvements in interest expenses and taxes have given a boost to net income, which has given encouragement to some investors already enticed by the company's low price-to-earnings ratio. Similarly, Wal-Mart's stock is starting to show some of its best growth in years, presumably because the stock was simply getting too cheap to pass up. It's not as if sales or profits have been improving much.

I continue to think that Dollar Tree is a superior company to its competitors, but as an investor, I would wait for this deep discounter to be on discount itself. In the meantime, add Dollar Tree to My Watchlist to find out if its growth slips any further in the coming quarters.

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Fool contributor Jacob Roche has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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