It has been almost a year since bottom-feeding retailer Dollar Tree Stores Inc. (NASDAQ: DLTR) merged with its ailing rival, Family Dollar. This makes it the largest operator of small box discount stores in North America with around 13,600 locations in 48 U.S. states and five Canadian provinces.
Naturally, investors will be wondering if Dollar Tree is actually making money from the arrangement. The answer to that question is unfortunately no; Dollar Tree is still losing money, but it is accumulating cash. The retailer reported a free cash flow of -$174.4 million on October 31, 2015, even though its revenues have been increasing.
How Dollar Tree Is Like Amazon
Dollar Tree has done very well in the revenue department; it reported a TTM revenue of $12.61 billion for the third quarter of 2015, a $4.249 billion increase over third quarter 2014. The problem is that increased revenue is not necessarily being converted into cash or profit.
Dollar Tree reported a net income of $259.9 million on October 31, 2015, down from $605.9 million in 2014. That means the Family Dollar acquisition actually cost Dollar Tree $346 million in income. Like Amazon.com Inc. (NASDAQ: AMZN), Dollar Tree seems to have a strategy of acquiring additional revenue at the expense of income, a sort of get big fast, and let the profits be damned strategy.
Dollar Tree Has a Lot of Cash
Dollar Tree has something else in common with Amazon; it likes to keep a lot of cash in the bank. On October 31, 2015, Dollar Tree reported cash and short-term investments of $1.111 billion, more than double what it had in the bank just a year earlier when it had just $407.6 billion in the bank.
In contrast, the far larger Target (NYSE: TGT) reported $1.77 billion in the bank on October 31, 2015, on revenues of $73.91 billion. The largest small box operator, Dollar General (NYSE: DG), had cash and short-term investments of $182.51 million and revenues of $20.67 billion.
This makes Dollar Tree a mixed bag as investments go; it is growing and accumulating a lot of cash, but that cash is not necessarily available to investors. Like Amazon, Dollar Tree seems to be obsessed with cash and growth; the Everything Store had $14.43 billion in the bank on September 30, 2015, and revenues of $100.59 billion.
Another reason why Dollar Tree might be accumulating that money is that unlike Dollar General, it does operate outside the U.S., in Canada. Therefore, Dollar Tree could be parking some cash overseas to avoid U.S. taxes.
Is Dollar Tree Entering the Death Spiral?
One thing is clear: Despite its cash and short-term investments, Dollar Tree is definitely not making money. This can be ascertained clearly from its cash from operations figures.
In October 2014 Dollar Tree reported generating $815.9 million in cash from its operations. By October 2015 that number had fallen to $487.80. This calls the whole merger into question because the amount of money Dollar Tree is making from its operations has dropped dramatically since it occurred.
In January 2015, right before the merger, Dollar Tree reported $925.8 million in cash from operations; that fell to $858.4 million in April 2015 and then went off a cliff, falling to $515.8 million in July and $487.8 million in July. It might be too early to say, but cynics would detect the beginnings of the death spiral here.
The death spiral occurs when the cost of keeping a retailer’s doors open eats up all its cash. It is not clear if this is going on at Dollar Tree; after all, the company has the expense of closing stores and of reorganizing the very badly run Family Dollar.
Although, it is obvious that Dollar Tree could have had a very good Christmas season this year and still report a negative cash flow. It is hard to see how even a great Christmas would help Dollar Tree.
Why Dollar Tree Is Not Making Money
Naturally, many people will be wondering why Dollar Tree is not making money from this merger. One obvious theory is that it does not control all of its own supply chain.
Many of the items sold at my local Dollar Tree, including cigarettes and candy, are delivered by McLane, the retail logistics company that is part of Berkshire Hathaway (NYSE: BRK.B). I actually see McLane trucks at my local Family Dollar more often than I see Family Dollar trucks.
That means part of the money that should be going to Dollar Tree’s family line is instead going to Warren Buffett. The Dollar Tree/Family Dollar merger appears to be a good deal for Berkshire Hathaway investors but not for Dollar Tree stockholders. Nor is it just Berk Hath; I see other companies like Frito Lay and the Meadow Gold dairies doing a lot of the stocking at Family Dollar.
If it wants the Family Dollar merger to succeed, Dollar Tree will have to take control over more of its logistics, much as Amazon is trying to do. That will be a very expensive proposition that will involve leasing or hiring semi-tractors and trailers, building or buying fulfillment centers and hiring some expensive employees, including truck drivers, some of whom now make as much as $73,000 a year.
Nor is paying outside suppliers the only cost Dollar Tree faces. There are labor expenses. My local Family Dollar has a high turnover rate; I see different people behind the register almost every time I go there. Hiring and training employees can get expensive fast.
Working conditions at Family Dollar are also terrible and will need to be improved. The U.S. Occupational Health and Safety Administration (OSHA) just fined Dollar Tree $825,000 because of safety hazards at its stores. The safety hazards included blocked emergency exits, blocked emergency routes, improper access to electrical equipment and poor material storage.
News articles indicate that the fines arose from numerous citations at Dollar Tree, which indicates serious management problems at its stores. The company will need to spend a lot of money to improve conditions.
My take is that Dollar Tree is not going to make money anytime soon even if it experiences significant revenue growth. Those that want to profit from the dollar store boom should avoid Dollar Tree and its archrival Dollar General; instead, they should buy Berkshire Hathaway. Berk Hath and McLane are going to make money even if Dollar Tree goes down the death spiral.