At the end of November, Dollar Tree (DLTR) reached a new high as the stock has traded sideways since 2015. What’s happening and is this a good time to buy? Investors who have bought into DLTR have been over and over again disappointed by its performance each time reaching a new high. It’s important to understand the stock psychology can impact how and when to buy into it should one decides to do so.
Chart 1: stars showing new highs and support levels at $120 and $90
Psychology of this stock
Since 2015, its direct competitor Dollar General (DG) has gone up 225% while Dollar Tree rose 100%. With each new high reached since 2015, it’s followed by insufferable patience as it lagged for months before reaching a new high before falling back down. Without any dividends coming from this stock, money is literally not falling off the tree. This entire consolidation period from 2015 to 2022 essentially builds a very solid base but at the same time, frustrated investors will likely want to dump their shares as soon as they get rewarded and move on to another stock.
We can infer from the chart that the support levels may be at $120 or $90. Depending on how severe the next market corrections will be, the stock may re-test some of these levels.
Reaching new highs
With the stock running up 50% from its low back in September, the latest news that fuels this speculation is the fact that activist investor Mantle Ridge has taken a $1.8 billion stake in the company. This CNBC article explains clearly what Mantle Ridge’s strategy may look like. The firm has a 5.7% stake in the company plus derivatives that gives a total economic exposure of just under 10%. This really puts the skin in the game for Mantle Ridge to want to see their investment a success. It has been reported that it is working with Rick Dreiling, the former CEO of Dollar General as part of its strategy.
The next thing to do is to figure out if this is a good value stock. As you know, I am not a fan of looking at valuation metrics like PE, price-to-book or price-to-sales. Especially in this case, these metrics are now all showing at the higher historical valuation ranges. Especially when a company stock significantly breaks out from a consolidation as in this case, I am a believer that the stock know something more than the fundamentals itself. Investors have taken note and are willing to bet on the future. There’s more to the financial valuation than meets the eye.
The news of Dollar Tree to raise its prices from $1.00 to $1.25 is music to investors as many have hoped for this day to come. This is in addition to its announcement back at the end of September that it plans to offer a multi-price point strategy by offering products at $1, $3 and $5 levels. Dollar Tree has already announced that it is on track in 2021 to have 500 Dollar Tree Plus stores by fiscal year-end to offer these products at different price levels. Another 1,500 stores are planned for fiscal 2022, and at least 5,000 Dollar Tree Plus stores are expected by the end of fiscal 2024.
There is however significant value in this company as shown by this chart below. Revenue per share has been growing since 2015 while the stock price languished. During this time, the markets experienced several corrections (including the 2020 pandemic) and Dollar Tree was able to withstand market shocks.
Chart 2: Stock price and revenue per share.
Another good way to compare value would be to look to similar stocks that tend to move in tandem. Here, you can see Dollar Tree has lagged since 2019 while Dollar General continues to move higher with the markets. While sure one can point out that this is well explained by the economics of Dollar Tree over the past several years, the fact that investors have taken note of the recent developments over at DLTR and ready to bet on its future. It can be safe to assume that value has been unlocked and we may be looking at the stock being re-evaluated closer to what Dollar General is worth.
Chart 3: DLTR vs. DG
The company also increased its share repurchase plan by $1 billion from its initial announcement back in March for an amount of $1.45 billion.. The CEO said “In fiscal 2021, we have repurchased $950 million of shares. Over the past several years, we have paid down more than $4 billion in debt and returned to an investment grade rating. As a result, with the meaningful free cash flow from our business, we expect to maintain share repurchasing as an important part of our capital allocation strategy.” What’s interesting is the company is issuing $1.2 billion of debt at around 3% to repurchase the stock. As I have explained in the past, borrowing may actually be a good thing if it can balance an optimal capital structure. As the CEO has paid down over $4 billion in debt over the past few years and now it’s taking on more to buy back shares, this shows how committed the company is in returning value back to its investors.
So what’s the verdict?
In all, this is very good news. With an activist investor help make things moving forward with the company now ready to raise prices and buy back more shares. Certainly the numbers such sales and earnings will not show up in the financials just yet. But if you have confidence that these actions will increase earnings in the coming years, it’s certainly a big buy signal.
When should I buy it?
Should you be buying it now that the stock is at an all-time high? Remember when I said the psychology of this stock will be a crucial role in this decision earlier. Given the stock is at a high is based on speculation and hope, I would not be surprise that the stock will pull back down to its next support level of $120 the moment the company misses the next earnings or when the market is hit by the next correction. Given the recent news and uncertainty over the Omicron variant and the high market valuations, it’s not hard to sit back and wait for the next correction.