Dollar Tree, Inc. (NASDAQ:DLTR) is one of the companies that are set to exploit the ongoing trend of consumers' increasing focus on value with significant opportunity to grow its store base, and expand margins.
Dollar Tree operates discount variety stores in the United States and Canada. Its stores offer merchandise at the fixed price of $1.00. Dollar Tree, a Fortune 500 Company, operated 4,842 stores in 48 states and 5 Canadian Provinces as of Aug. 3, 2013.
However, bears may be watching the leverage metrics, but solid free cash flow generation should alleviate investor concerns. The company announced the issuance of $750 million of notes in three tranches as part of its recent $2 billion stock buyback.
Previously, the company had no outstanding bonds and had merely $250 million outstanding on the company's $750 million credit facility that expires in June, 2017. In fact, the company has had only $250 million in outstanding debt since fiscal 2004.
The company ended fiscal 2012 with a debt-to-capital ratio of only 14 percent, which was relatively low in the dollar store space and overall broad-line retail space. So, in terms of traditional debt (as opposed to lease commitments), the company certainly has room to take on leverage.
"We estimate the $750 million debt issuance will drive lease-adjusted debt-to-capital to 81%, which compares with our prior estimate of 70%. A ratio of 81% would represent the highest in the company's history, surpassing the 80% ratio in 1995," BMO Capital Markets analyst Wayne Hood said in a client note.
The company is somewhat constrained by its lease commitments as it leases 100 percent of its store base. On a lease-adjusted basis, the company's debt-to-capital ratio ended fiscal 2012 at 70 percent, which is in line with the company's historical range of 62-73 percent over the last 10 years.
During fiscal 2009-2012, the company grew EBITDA margin from 12.76 percent to 14.95 percent, an increase of 219 bps. Additionally, the company! exhibited a three-year sales CAGR of 12.2 percent, growing sales from $5.23 billion $7.39 billion. These two factors allowed the company to grow EBITDA dollars from 17.9 percent annually from 2009 to 2012, from $667.6 million to $1.1 billion.
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"We forecast a much slower deleverage over the next five years than during the prior three years. We estimate the company will end FY2017 with a lease-adjusted debt-to-EBITDAR ratio of 2.69x, which compares with our estimated FY2013 ratio of 2.97x," Hood said.
While the estimated deleverage over the next five years does reflect a declining rate in comparison with the prior three years, investors should note that the company's ability to grow cash flow from operations each year should continue to outweigh the company's growth capital needs. For instance, the company is expected to end 2013 with cash from operations of $804 million versus capex requirements of $325 million.
As such, healthy cash flow generation should serve to allay any concerns investors may have about the company's leverage. Moreover, because of the manner in which the company laddered the maturities of the bonds, refinance risk is not on the cards given the amount of free cash flow the company is expected to generate in the future.
In addition, the company should continue to see strong square-footage growth, something relatively hard to find in the broadline retail space.
"We continue to believe the company is in a position to eventually operate 7,000 stores in the US and 1,000 stores in Canada," Hood said.
This compares had a store base at the end of the second quarter of 4,682 in the US and 160 stores in Canada (which have all been rebranded as Dollar Tree Canada, at this point)
Meanwhile, the stock is still not expensive, in our view, given robust share repurchases and improving metrics. The stock trades at 17 time! s its for! ward earnings. The stock has traded as high as 20.8 times and averaged 16 times over the last seven-years.
"We believe it's unlikely the stock will trade at 20x absent 5%-6% comp-store sales growth and more robust EBITDA margin expansion that we are presently forecasting," Hood noted.
Moreover, the company continues to outperform dollar store peers in margin and returns. Dollar Tree could achieve a pretax return on invested capital (ROIC) on gross investment in fiscal 2014 of 23.5 percent, which compares with 17.4 percent at Dollar General (NYSE:DG) and 16.1 percent at Family Dollar (NYSE:FDO).
Much of the superior ROIC is driven by the company's margins, as EBIT margin at Dollar Tree is estimated at 12.6 percent in fiscal 2014 compared with 10 percent at Dollar General and 6.5 percent at Family Dollar. In other words, higher profitability drives higher returns.
"The superior returns are not a function just of higher margins; the company is able to achieve returns as a result of its lower capital investment resulting from the company leasing all of its stores," Hood said.
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