Should You Invest in Dollar Tree?

Budget-conscious consumers have been unwilling to splurge as of late, even though the holiday season is knocking at the door. Sales at dollar stores, which offer products at low prices, have been affected as a result. While the company has been performing reasonably well over the last few years this means that Dollar Tree's miss in its third-quarter results should not have been surprising. Although the retailer witnessed growth, its results did not match up to the Street's expectations and Wall Street reacted accordingly. All of these events beg the question: Might there be an opportunity here for Foolish investors? 

Analyzing the miss
Revenue grew 9.5% over the previous year's quarter, clocking $1.88 billion against an estimate of $1.91 billion. Its earnings also jumped 13.7% to $0.58 per share, though analysts had expected earnings per share of $0.60. Although the retailer could not live up to analyst's expectations, both the top and bottom lines of the company grew. One of the key drivers for revenue growth in the quarter was the addition of new stores. Dollar Tree opened 117 new stores during the quarter, adding to its top line.

Its existing stores also witnessed increased consumer traffic, leading to a growth of 3.1% in comparable-store sales. As more customers visited the stores, demand for consumer basics and seasonal merchandise increased. The retailer controlled its costs well, which led to widening of its gross margin by 10 basis points. Dollar Tree's same-store sales were better than its peer Family Dollar Stores , which had flat comparable-store sales growth in its most recent quarter.

What makes Dollar Tree attractive?
Dollar Tree is a dollar store chain that has not resorted to emphasizing low-margin products to boost its top line. In fact, it has expanded its margins by increasing private-label offerings. This is opposed to its peer Dollar General , which recently added tobacco to its product portfolio because it has a lower margin. The addition of tobacco has led to higher sales for the company; its same-store sales grew 5.1% in the most recent quarter as new products such as fresh food and tobacco were added. However, this led to a contraction in the gross margin of 65 basis points.

Dollar Tree has also expanded its frozen and refrigerated food items since it is witnessing significant demand for such products. Even Family Dollar is trying to boost its sales of refrigerated and frozen foods by partnering with McLane, adding to its wide assortment of products.

Dollar Tree's strategy to enhance its products at the checkout lanes for impulsive purchases has been quite fruitful as the category saw higher sales. Moreover, the company has also started accepting food stamps at its stores, a move that should also attract more customers.

Apart from expanding its product assortment, the retailer is also expanding its reach. It plans to add 340 new stores during the current fiscal year, 117 of which were opened during the third quarter. However, the company has a much smaller store base as compared to peers such as Dollar General and Family Dollar Stores. Dollar General has more than 10,000 stores and Family Dollar has approximately 7,900 stores, while Dollar Tree's store count stands at 4,953. This means that Dollar Tree has more room to grow by expanding its presence.

The road ahead
Dollar Tree seems to have a decent future as it posts great growth. It also claims that it products transitioned well into merchandise for the holiday season and Thanksgiving, which will help attract customers. It has been adding products to its gift collection for the peak season.

Dollar Tree won't be the only one to make efforts to improve sales. Its peers are gearing up to snatch away market share. It will be interesting to see how each company fares in this competition.

Dollar Tree faces stiff competition from its peers. The biggest challenge for the retailer is combatting this competition and maintaining customer attention. Although the company's strategy of selling higher-margin items is working well, competitors' wider collection of items can prove to be a drawback. Moreover, the company's outlook disappointed investors. For now, staying on the sidelines is the right thing to do.

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Pratik Thacker has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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