Dollar Tree 's stock continues to move higher. It's jumped 25% over the past three months in large part because of its possible acquisition of Family Dollar . But the dollar store chain's stock was steadily rising before that, and over the past five years has quadrupled in value, far beyond an 86% gain by the S&P 500.
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With that kind of stock appreciation, though, is there room for further growth?
Dollar stores remain a competitive threatIn an effort to block a merger between Dollar Tree and Family Dollar and stay competitive with deep discount mass merchandisers like Wal-Mart,Dollar General has also expressed its own commitment to acquire the Family Dollar chain.
It might be better if Dollar General did win. Dollar Tree's size, different corporate culture, and customer demographics all speak to trouble digesting such a big acquisition. The merger would nearly triple the size of its footprint and double the revenues. It would also alter its core concept from pay-one-price to one of multiple price points, which is adifferent business model altogether.
And Family Dollar remains a troubled company. It hasn't enacted much, of a turnaround plan yet other than to single out that it was for sale. It will be up to Dollar Tree and its shareholders to shoulder the burden of effecting a reversal strategy, and such large acquisitions rarely seem to work out as planned.
Wal-Mart remains a competitive threat. The company recognizes the potential impact dollar stores have on its continued profitability and is putting more time and resources into opening its smaller format Neighborhood Markets, which are generally 42,000 square feet. Wal-Mart has also merged its tiny Wal-Mart Express concept into Neighborhood Markets, which range in size from 12,000-15,000 square feet. Though larger than the average 8,000 square foot Dollar Tree store, Wal-Mart's small footprint stores arekey to its growthnow and in the future.
Expansion opportunities aboundIn addition to potentially acquiring Family Dollar to beef up its competitiveness, Dollar Tree is exploring building out its online presence as well as further expansion in Canada where it already has 205 stores.
Dollar Tree thinks the Great White North can sustain 1,000 stores, which would put it on par withDollarama , Canada's leading dollar store with 900 stores in operation. From a pricing standpoint, Dollar Tree's $1.25 price point (based on the Canadian dollar) could draw customers away from Dollarama, which prices its goods at $3 or less.
Dollar Tree has figured out the formula for making customers come back: make it cheap.
The pay-one-price model has resonated well with consumers and Dollar Tree has no intention of changing.
The online opportunity is a newer channel. Dollar Tree Direct provides the dollar store chain the chance to broaden its customer base, drive incremental sales, expand brand awareness, and attract more customers into its stores. It's also increased the site's functionality by providing dedicated areas for both crafts and seasonal videos.
The company has had success tinkering before. Providing consumers with a broader selection of consumable items in expanded refrigerator and freezer cases have proven to drive more traffic to their stores. They tend to be lower margin items, but they generate higher turnover and customers buy additional items when they come in for the frozen goods.
It reigns in domestic markets with strong profitabilityDollar Tree generates more profit from every dollar of revenue produced than any of its domestic rivals, and as its third quarter results indicate, margins are widening.
The market, though, has put a premium on Dollar Tree's valuation as a result, and on any number of financial metrics it remains the more expensive stock.
With that said, based on its earnings growth prospects, Dollar Tree's stock could be seen as being fairly priced. It goes for 23 times trailing earnings and 19 times estimates and its P/E ratio is just 1.6 times its projected earnings growth rate. Of course, its value may be puffed up a bit on the prospects of the Family Dollar acquisition going through, so we're back to it tilting toward being on the expensive side.
The wildcard here is the acquisition of Family Dollar.If Dollar Tree loses out on the merger, the market could whack its shares too, although I'd likely find Dollar Tree's stock much more attractive at those lower price points.
The article Is Now the Time to Buy Dollar Tree Inc.'s Stock? originally appeared on Fool.com.
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