Dollar Tree’s Family Dollar Gamble is Paying Off

The extremely risky gamble Dollar Tree Stores (NASDAQ: DLTR) took by buying Family Dollar appears to be paying off. The discounter’s TTM revenues grew by $9.631 billion between April 2015 and April 2016.

Dollar Tree reported revenues of $8.779 billion in April 2015 that increased to $18.41 billion a year later. If this rate of growth keeps up; Dollar Tree’s revenues could soon approach those of its archrival, Dollar General (NYSE: DG). Dollar General reported a TTM Revenue number of $20.37 billion on January 31, 2016.

The revenue numbers alone vindicate Dollar Tree’s decision to buy the ailing competitor in January 2015. The retailer now has the resources to compete with Dollar General, larger discounters like Walmart (NYSE: WMT), grocery giant Kroger (NYSE: KR) and the growing menaces of Amazon (NASDAQ: AMZN) and Aldi.

Dollar Tree had a Great Year

Dollar Tree’s revenue has grown for every quarter since the Family Dollar acquisition in January 2015. The recent increase in growth has been dramatic; Dollar Tree’s revenue increased by $2.91 billion during first quarter 2016 alone. Ycharts reported that the TTM revenues rose from $15.5 billion in January to $18.41 billion in April.

Dollar Tree also had a very good holiday season on the revenue front; revenues increased by $1.89 billion during fourth quarter of 2016. The discounter reported TTM revenues of $12.61 billion in October 2015 that grew to $15.5 billion three months later at the end of the year.

The logical question to ask here: is Dollar Tree making money off of all that revenue? The answer as is so often case with retailers is sort of.

Is Dollar Tree Making Money?

Dollar Tree reported a net income of $445.6 million on April 30, 2016. That was a big improvement over January; when it reported a net income of $283.4 million. It was also done from April 2015 when Dollar Tree had a net income of $530.5 million.

The recent increase in net income shows us that Dollar Tree is rebuilding its net income after the Family Dollar purchase but it still has a way to go to match Dollar General’s $1.165 billion net income for the fourth quarter of 2015.

Some of the other figures indicate that Dollar Tree will soon match Dollar General in net income; it reported a profit margin of 4.58% on April 30, 2016. Yet Dollar Tree still does not have much cash, the chain only had a free cash flow of $135.1 million for the first quarter.

Although Dollar Tree is generating a lot more cash, the chain reported $941.5 million in cash from operations on April 30, 2016. That was a dramatic improvement over July 2015 when Dollar Tree reported$515.8 billion in cash from operations. Since July 2015, Dollar Tree’s cash from operations increased by $425.7 million.

Dollar Tree is not Out of the Woods Yet

Despite the revenue and cash gains, Dollar Tree is far from out of danger. The retailer reported $933.7 million in cash and short-term investments on April 30, which indicates limited float. That figure was a slight increase over January 2015 when it reported $864.1 million in the bank.

Strangely enough Dollar Tree’s cash and short-investments greatly exceed Dollar General. The larger retailer reported having just $157.95 million in the bank in January 2016.

Dollar Tree is in a little better shape, but it will still need several quarters of revenue growth to approach stability. The limited amount of float it carries; puts Dollar Tree in a vulnerable position in a rapidly changing retail environment.

Dollar Tree’s Vulnerable Position

Dollar Tree’s greatest strength is also its’ greatest weakness; the chain’s massive footprint. Dollar Tree currently operates around 13,600 stores in 48 states and Canada.

The size is what allows Dollar Tree to generate all that revenue, but it also provides for big operating costs. Dollar Tree has been able to control some of those costs through its operating model which includes strategies like not allowing carts to leave the store.

Family Dollar with its large number of far-flung rural locations and more traditional business model is a bigger problem. Since Family Dollars seem to have a larger inventory and wider selection of merchandise; stocking costs are higher. Other high operating costs at Family Dollar include; a larger cooler and freezer section, and the presence of more name brands.

Family Dollar is also very vulnerable to direct competition from aggressive discounters like Kroger, Aldi and Walmart. A major threat to Family Dollar’s rural business is Walmart’s Free Shipping pass; which allows for unlimited two shipping on items purchased through Walmart.com.  The shipping pass recently went live with a cost of $49.99 a year.

Rural residents are more likely to shop online because they have a longer drive to reach bigger retailers. Many rural; and small-town residents, were earlier adopters of Amazon, so they’re already used to online buying.

Another growing threat is Aldi, with its low grocery prices and no frills business. Aldi targets the same low income customers that shop at Family Dollar and Dollar Tree. Also on the horizon is the threat of a combined Walgreen Boots Alliance (NASDAQ: WBA) and Rite Aid (NYSE: RAD); which could create a small box retail chain that rivals Dollar Tree and Dollar General in size and scope. The new retailer will have the added benefit of being able to tap prescription revenues, because Dollar Tree lacks pharmacies.

News reports indicate that successfully acquiring Rite Aid would give Walgreen around 13,000 stores in the United States. Dollar Tree currently operates 13,600 stores and Dollar General operates around 12,483 stores with many more planned. Walgreen could become Dollar Tree’s largest direct customers in the very near future.

Is Dollar Tree a Value Investment?

Dollar Tree is far from a value investment because of its high price and limited amount of float. Dollar Tree shares were trading at $91.34 on June 10, 2016.

I would advise investors to stay away Dollar Tree because of the risk. There are some far better retailers out there such as Lowe’s (NYSE: LOW).  Lowe’s is cheaper than Dollar Tree and it pays a dividend.

Investors should stay away from Dollar Tree, until we see if its’s risky Family Dollar acquisition actually pays off with large income increases. Until then Dollar Tree is one stock to avoid.