Here’s Why Dollar Tree Is Discount Retailer to Watch

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The dollar stores have been fairly popular investments over the past several years. Americans are earning less money, and prices of consumer goods are rising. Furthermore, access to credit is down significantly after the financial crisis. As a result, we are seeing the rise of the dollar store industry.

Dollar stores exist to offer consumers extremely low prices on consumer staples. While items don’t always cost $1, they are generally very inexpensive. The idea has done extremely well, as is evidenced by these companies’ rising sales and profits. Furthermore, their stocks have outperformed the market while they remain cheaper than the S&P 500 on a price-to-earnings basis.

However, recently we have seen some drama develop in the sector. Family Dollar (NYSE:FDO) has been underperforming due to poor execution, and as a result its profits are down, along with its stock price. This led activist investor Carl Icahn to take a stake in the hopes of shaking the company up. He believes that CEO Howard Levine is not the right man for the job.

One way he proposes to create value is to sell the company to fellow dollar store operator Dollar General (NYSE:DG). He believes that this company’s CEO, Richard Dreiling, is an excellent manager for this industry, and believes that the Family Dollar franchise is worth more to Dollar General under the stewardship of Dreiling than it is as a standalone company. Such a merger would benefit the entire industry, as there would be less competition, and the two companies could reduce their total administrative expenses over time.

However, Icahn’s plan might have to wait a while, as Dreiling recently announced his retirement. It is unlikely that Dollar General’s board is going to go through with a merger given that it has to now find a new chief executive.

Meanwhile, Family Dollar recently reported mediocre earnings as its troubles continue, and the stock fell 3 percent on the news. Now, most of the “Icahn premium” that had been built into the stock has dissipated. Unless Icahn can broker a sale of Family Dollar or unless he can shake up management, it seems that the company’s troubles are set to continue.

But while Dollar General is facing the resignation of its star CEO and a potential cumbersome merger, and while Family Dollar faces the prospect of no merger, continued underperformance, and an Icahn exit of a nearly 10 percent position, we have yet to mention Dollar Tree (NYSE:DLTR). With all of the drama surrounding Family Dollar and Dollar General, it seems that an investment in one of these stocks is predicated upon the aforementioned events rather than on fundamental attributes such as cash-flow and sales growth.

With this in mind, and given that there is still a secular bull market in dollar stores, I think that Dollar Tree is the only one worth investing in for the time being. Other than a weak fiscal 2014, ended in February, the company is growing its earnings per share at a double-digit clip thanks to timely stock repurchases. Furthermore, the company is recovering as earnings growth is reaccelerating. Despite this, the stock is 10 percent off of its high, and it trades at about 19 times earnings, which is below the S&P 500’s 22 trailing earnings multiple.

But what is most compelling about Dollar Tree is that in the event of a recession, it actually stands to benefit considering that consumers will be looking for bargains and they will find them at Dollar Tree. Thus I think that the company has a very high probability of maintaining its earnings stream through almost any environment, and yet for other companies with a similar advantage — e.g., Colgate Palmolive (NYSE:CL) – we are seeing price-to-earnings multiples in the high 20s.

With this in mind, the stock trades at about $55 per share, although there is very strong technical support at around $50 per share. If we see this price, I would consider taking a position, especially if it is on the back of general market weakness — again, a weak consumer market is a catalyst for Dollar Tree. If, however, it falls on a company-specific or an industry-specific event, I would have to re-evaluate my position.

Disclosure: Ben Kramer-Miller has no position in any of the stocks mentioned in this article.

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