By Neil Saunders
After stumbling last quarter, Dollar Tree is back on track with a robust set of numbers. Total sales rose by a respectable 4.6% with positive sales uplifts from the Family Dollar and Dollar Tree formats. Net income increased by almost 67%. Although none of this came from an improvement in operating income which actually fell by 12% over last year, it was a function of reduced interest expenses.
Although both banners saw sales improvements, a clear divergence between Dollar Tree and Family Dollar stores remains. The former is growing at a much faster rate and is more profitable. The latter has relatively slow growth and delivers a meagre 3.2% operating margin, well below the 13.2% contribution from Dollar Tree. Family Dollar remains a drag on performance and its transformation will continue to absorb both management time and company capital for the remainder of this year and beyond.
Fortunately, the steps being taken to improve performance at Family Dollar appear to be working. Refurbished stores are delivering good sales uplifts and offer an improved selection of merchandise. Customer numbers and conversion rates are also much improved. This, along with plans to close some very poor locations and rebrand others to Dollar Tree, should help to reverse underperformance. We are not under the illusion that a complete turnaround of the business will not be delivered quickly nor will it come cheap. This will both reverse the benefit of synchronistic cost savings from bringing Dollar Tree and Family Dollar together and raise questions over the amount paid for the business.
The transformation of Family Dollar isn’t the only pressure Dollar Tree faces as it moves into this fiscal year. The impact of tariffs is also likely to weigh down on performance, even if the company has established plans to mitigate some of the cost increase.
There is a concern that the impact of tariffs on consumers as prices in the general economy rise. Both Dollar Tree and Family Dollar have a much heavier exposure to very low-income shoppers than Dollar General and these individuals are much more likely to be affected by inflation, leading to possible reductions in the amount they buy. This has the potential to clip sale volumes and growth.
The second is the longer-term ability of Dollar Tree to manage higher product costs if tariffs remain in place for a long period of time because of its one-dimensional pricing model. The recognition of this has led Dollar Tree to explore the potential for multi-level pricing where it stretches some of its products above the $1 mark. This is a sensible move that will give the company significant flexibility in dealing with cost increases. It would also facilitate improvements to the range, including the introduction of some more ‘premium’ items and brands. However, the move brings with it the dangers of complexity and confusion, both of which could undermine customer trust in what is currently a simple and easy to understand retail model.
Overall, we remain positive about Dollar Tree. The company is making progress and is evolving to cope with challenges across its business. However, the cost of managing these things and wider pressures in the economy are likely to subdue performance.
Neil Saunders is managing director of research firm GlobalData Retail