Will Family Dollar's Performance Improve Again for Dollar Tree in Q1?

Dollar Tree (NASDAQ: DLTR) investors probably won't get much insight about how the deep discounter's test on raising prices is going when it delivers its first-quarter earnings report on May 30. Activist investor Starboard Value had been pressing for changes at the company, but this strategic shift was only agreed to last month, so it's still too early to assess its impact on sales and profits.

Yet Starboard Value backed away from its insistence that Dollar Tree sell the Family Dollar chain (and withdrew its slate of nominees for the board of directors) after that chain reported better than expected fourth-quarter results. So this time around, investors will be looking for clarity on whether that improvement was a one-off event, or if the deep discount retailer is finally gaining traction.

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Questions about Family Dollar remain

Starboard Value's promise of a proxy battle at Dollar Tree's annual meeting suggested the possibility of a big shakeup, but the capitulation by an activist investor known for taking hard stances against perceived management ineptness suggests things may be getting better.

After three years in which Dollar Tree's overall results were dragged down by the discount chain it acquired in 2015, in Q4, Family Dollar came through with same-store sales growth of 1.4%. The company has closed down dozens of underperforming stores, and renovated hundreds of others. Performance was even better at those updated locations, with comps up more than 10% year over year. As a result, management said it would accelerate its remodeling plan, with a goal of revamping 1,000 stores this year.

Starboard said because management "appears to have conviction" the Family Dollar turnaround is real, it was willing to relent. But the Q1 report will be a bit more telling on that score, because a jump in fourth-quarter comps isn't unprecedented for the chain.

In 2017's fourth quarter, Family Dollar's comps grew 1%, only to slide again for the first three quarters of 2018. In fact, comps were up 0.4% for all of 2017. That doesn't mean the chain was healthy at the time.

Yet if remodeling stores can consistently produce double-digit percentage increases, that would obviously be a significant improvement, even if investors shouldn't expect such growth rates to be maintained for any length of of time. The bar has been set pretty low for Family Dollar because of its underperformance, so a single big step up isn't a particularly difficult task to accomplish, even if the brand is not actually on the mend.

Also, the chain will be closing more stores, and its remodeling expenses are frontloaded to the first half of the year, so overall, the picture of the chain's health is going to be a bit muddled.

Tradeoffs coming

Washington's escalating trade war with China shouldn't be a big drag on Dollar Tree this quarter, nor even over the rest of 2019, since management accelerated its purchasing activity to get ahead of tariff hikes. Thanks to that advanced planning, as well as the fact that it factored tariff hikes into its guidance, Dollar Tree believes both of its chains will be able to weather the president's decision to increase tariffs on Chinese imports to 25%. But if the conflict isn't resolved, it could start hitting the chain's bottom line next year.

This year's fiscal Q1 numbers should also get an added boost because Easter fell within the quarter. But quirks of the calendar will likely cost it some sales later: There are six fewer shopping days between Thanksgiving and Christmas in 2019 than there were in 2018.

Back in 2013, when a late Thanksgiving squeezed the holiday shopping season, there was an all-out crisis in retail. That year saw the start in earnest of retailers launching their Christmas sales well before Black Friday. But fourth-quarter earnings are a long way off -- Dollar Tree has a number of bridges to cross between now and then.

A discounter in transition

Management's forecast was for Q1 sales in a range of $5.74 billion to $5.85 billion, based on a low single-digit increase in comps, with earnings in the range of $1.05 to $1.15 per share, down from the $1.19 it earned last year. Wall Street's consensus estimate is for earnings of $1.14 per share.

Because the turnaround maneuvers at Family Dollar are still ongoing, the picture Dollar Tree paints with its earnings report will be a bit cloudy, but investors should be able to see whether management's optimistic narrative still holds water.

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