Dollar Tree Is Finally Ready to Break the Buck

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A promised proxy battle for control of Dollar Tree (NASDAQ: DLTR) is not going to materialize after all. Private equity firm Starboard Value has withdrawn its slate of nominees to replace the dollar store's entire board of directors after the discount retailer said it would launch a significant trial of higher price points for the items it sells.

The hedge fund also advocated Dollar Tree sell its lagging Family Dollar chain, but following a quarter where comparable store sales growth exceeded 10% at remodeled locations, Starboard Value seems willing to stand by Dollar Tree's "conviction" that its turnaround plan for the chain is finally on track.

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Pennies on the dollar

Dollar Tree's performance has lagged behind rival Dollar General since it won the price war to acquire the Family Dollar chain, with profit margins under pressure and its stock similarly underperforming. Starboard Value, which owns 1.7% of Dollar Tree's shares, said the solution was to shed Family Dollar and to "break the buck", or raise prices throughout the store.

The plan has numerous potential benefits. Dollar Tree's profit margins had led the industry prior to the acquisition while Family Dollar's badly trailed. It was taking over a damaged company and trying to make it better, but the results so far suggested it's only making Dollar Tree worse.

That seems to have changed in earnest beginning with the fourth quarter. Family Dollar experienced its strongest comps growth of the year, as same store sales rose 1.4%, and when looked at over a two-year period, comps increased by 130 basis points. As noted before, the performance was even better in the 522 stores it remodeled, so this year the company is looking to renovate over 1,000 more stores.

Yet it also realizes that some Family Dollar locations just aren't performing well, and it accelerated store closings, shuttering 122 and rebranding 52 to Dollar Tree. Management expects to close 390 more Family Dollar locations in 2019 while converting an additional 200 to Dollar Tree.

Pricing in opportunity

As for the higher prices, the hedge fund said it wasn't calling for Dollar Tree to adopt Family Dollar's multi-price point business model, but rather to raise prices just a little, such as another dollar or so, as a means of improving the quality and selection of the products sold. It pointed to the success of Canada's Dollarama when it undertook a similar initiative.

It's not the only discounter exploring higher price points. Tween and teen retailer Five Below is also experimenting with higher prices. Although its model is to sell everything at five dollars or less, it is testing in a limited number of stores having a bin or aisle that contains items priced as high as $10.

The value proposition for the customer still remains very much intact, as they might not mind paying slightly higher prices if it meant a broader range of products to choose from. It's also not a concept completely foreign to Dollar Tree either.

The deep discounter operated the Deal$ chain that ran more like Family Dollar by offering a number of price points, but Dollar Tree closed it down after making the acquisition. And more recently, Dollar Tree has been testing exactly what Starboard Value was asking for, a selection of merchandise that is offered at marginally higher prices.

Details on how extensive Dollar Tree's new price experiment is going to be were not provided. Starboard Value said the test would be "significant", and Dollar Tree said it was committed to delivering "sustainable value-creation for shareholders while providing the best possible experience and value for our customers." But both sides seemed to be in agreement the experiment would be good for the retailer.

The key takeaway

It's taken four years for Dollar Tree's investment in Family Dollar to finally start paying off, but this is still a preliminary view. Family Dollar still needs to prove it can maintain the healthy trajectory it's on, while the higher price points at Dollar Tree stores should benefit the bottom line pretty quickly, and could expand even more if it rolls out the test nationally.

The markets aren't especially happy that Starboard Value has withdrawn its nominees, as the stock pulled back slightly on the news, but a cooperative dialogue, rather than an adversarial one, may be best for the company and its shareholders alike.

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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool recommends Five Below. The Motley Fool has a disclosure policy.