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Dollar stores seem to be set up very well right now. Their discounted goods are enjoying robust demand due to the uneven recovery in the labor market and broader economy. Millions of American consumers are still struggling, and continue to scale down their shopping habits. This has created a strong tailwind for the deep discount stores.
And yet, Dollar Tree (NASDAQ: DLTR) whiffed on earnings when it reported its second-quarter results Tuesday. The stock fell nearly 10% in market trading after reporting earnings before the opening bell. It closed Tuesday down more than 8%.
Consequently, Dollar Tree’s acquisition of Family Dollar, completed in July, is under intense scrutiny now.
Dollars Don’t Grow on Trees
Dollar Tree posted a $98 million loss last quarter on $3.01 billion of total sales. Sales grew 48% year-over-year, which looks fantastic on the surface. But $811 million of that revenue was due to the integration of Family Dollar and its more than 8,200 stores nationwide. And rising costs more than offset the increase in net sales, which is why Dollar Tree swung to a loss.
Total sales missed analyst estimates, which called for $3.04 billion, according to forecasts compiled by Thomson Reuters. Dollar Tree management cautioned investors that the integration is not going as smoothly as was previously anticipated. The company is having to spend more on renovating stores and improving merchandise.
Looking ahead, Dollar Tree expects third-quarter sales to more than double to a range of $4.78 billion to $4.87 billion, again due largely to the Family Dollar deal. But this projection also missed analyst estimates, which called for $4.91 billion.
Buyer’s Remorse?
When Dollar Tree bought Family Dollar, it was initially hailed as a great deal. The acquisition allowed Family Dollar to snatch up a struggling rival at a discounted price. Family Dollar was in disarray at the time, besieged by declining sales and a negative reputation among consumers for messy stores with cluttered products.
The merger instantly vaulted Dollar Tree to the No. 1 dollar store in the United States, usurping the title from close rival Dollar General (NYSE: DG).
But the acquisition has proven to be extremely costly. Focusing in on Dollar Tree, its same-store sales rose a very solid 2.7% last quarter. Same-store sales measure sales at stores open at least one year. That represented the 30th consecutive quarter of quarterly same-store sales growth.
This implies that there was nothing wrong with Dollar Tree in the first place, and that there was little reason to acquire a distressed competitor.
In order to make this acquisition accretive to profits, Dollar Tree will need to squeeze a great deal of costs out of its corporate structure. Fortunately, the company expects $300 million in cost savings per year by the third year out.
Dollar Tree stock isn’t cheap. Shares trade for 26 times trailing earnings. The valuation has expanded and the stock has registered strong gains since the Family Dollar buyout, based on rising optimism over the growth potential.
But now that the results are coming in, and Dollar Tree is losing money, that optimism is fading. If the company reports another loss next quarter, look out below.
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