Analysis: Family Dollar still a relatively weak format in a strong market
Although this is a reasonable set of results from Dollar Tree, they reveal two truths about the company. The first is the inherent challenge of running a low-margin, high-volume business in an environment where costs are rising. The second is the struggle to improve performance at the Family Dollar banner, which is still a relatively weak format in a strong market.
Looking at the first problem, Dollar Tree’s bottom line numbers are showing clear signs of erosion from cost inflation across many parts of its business. At operating level, income tumbled by 8.8% over the prior year. This was largely thanks to higher wages, a rise in freight and shipping costs, plus some exceptional fees related to hurricane damage. Although some of this has been mitigated by higher volume we remain concerned about future profitability as other negative headwinds, especially increasing tariffs, start to bite.
In our view, while Dollar Tree can and will take action such as changing suppliers, shifting pack sizes, and negotiating harder with suppliers, it is likely to be a net loser from any hike in tariffs. It is also, because of the single price-point nature of Dollar Tree stores, less able to cope than rival Dollar General. As is evident this quarter, there is some firepower in offsetting a decline in operating profit with lower income taxes and interest expenses, however, the runway for this is relatively short.
While Dollar Tree has limited control over external costs, it is fully responsible for the destiny of the Family Dollar format – which remains the weaker part of the business. From our data, a high proportion of Family Dollar’s shopper base goes there out of necessity rather than because they particularly want to. There is nothing wrong with this position, but it does mean that as financial conditions improve, or people feel they can afford something better, they are more likely to migrate away – especially in non-consumable categories. This trend has been evident across this fiscal year and shows few signs of slowing down. We also think that the format is vulnerable to the expansion of players like Aldi, which provides low-prices with a much more compelling and enticing range of products and a better in-store experience.
The challenge for the Dollar Tree group is to transform the Family Dollar experience so that it is more compelling and stimulates greater levels of loyalty. As much as we applaud the company’s efforts to date, including the store reformats and the introduction of new private labels, we believe that there is a lot more work to do on fixing up this side of the business. The whole customer experience needs to be elevated so that Family Dollar becomes a destination of choice rather than a retailer people visit by default. Inventory discipline is also needed to reduce the number of out-of-stocks which has been an issue in some stores and is an annoyance to customers relying on the chain for essential purchases.
Looking ahead, we are satisfied that the company will get to grips with Family Dollar in the medium term. Over 1,000 store refurbishments are scheduled for 2019 and around 200 stores will be re-bannered to Dollar Tree. There is also now more knowledge and a clearer strategy around how to shift the proposition to cater to the needs of both urban and rural consumers. These are positive steps, but as Dollar Tree is making the corrections in a very competitive market we believe results will take some time to filter through to the top line, and in the short term increased expenditure may put further pressure on an already challenged bottom line.
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