If investors anticipate a recession materializing, a natural, intuitive idea would be to focus on companies like Dollar Tree (NASDAQ:DLTR). As a discount dollar store, it provides critical consumer goods at much-needed bargain prices. However, the history of the enterprise performing reasonably well during down cycles might not repeat, which is a huge problem. Therefore, I am regrettably bearish on DLTR stock.
DLTR Stock Suffers from an Awful Reality Check
Prior to its recent fall, Dollar Tree seemingly offered a rational investment idea. Earlier this May, TipRanks reporter Marty Shtrubel mentioned that legendary investor Paul Tudor Jones anticipated a coming recession. Jones even stated that the red ink could possibly fly this fall.
If investors believed in this thesis – and it’s starting to look credible – DLTR stock would be a natural place to go. No, the underlying financials don’t really excite market participants. However, over the long run (minus a hiccup in Fiscal Year 2019), DLTR has been consistently profitable. And that’s not a surprise because, again, Dollar Tree provides necessary goods at discounted prices.
Also, while the company doesn’t exactly have the greatest balance sheet – especially with a low cash level relative to debt – it is a predictable business. Featuring solid top-line growth for the underlying retail industry, DLTR stock generally carries the right ingredients to weather a storm.
Unfortunately, it’s suffering a harsh reality check. Aside from the recent dip in its stock, DLTR stock now finds itself down about 26% for the year. Looking at key technical analysis indicators, sentiment for Dollar Tree sits at a Sell.
Taking a look at the options market, it’s clear that the smart money wants out. Most recently, a major trader bought 1,300 contracts of the Jan 19 ’24 150.00 put, paying a premium of $2.97 million. With few takers to the long side of the trade, investors should approach Dollar Tree with extreme caution.
History Might Not Repeat This Time
With DLTR stock struggling now, the volatility presents an odd contrast to its historical trend. Back during the Great Recession, Dollar Tree – after enduring the initial shock – managed to march northward. Unfortunately, the same trend might not occur this time around, and it has to do with its gross profit margin.
In Fiscal Year 2009, Dollar Tree posted revenue of $4.64 billion, up over 9% against the prior year’s result. Just as importantly, its gross margin stayed relatively stable from 2008 to 2009 at a bit over 34%.
However, fast forward to the most recent quarter ending July 2023, and the situation looks much different. While Dollar Tree posted revenue of approximately $7.33 billion – up over 8% against the year-ago quarter – its gross margin slipped to 29.2% from 31.4%.
Put another way, it appears that management is cutting prices or engaging in other promotional activities to boost the top line. What’s more worrying, Dollar Tree’s operating margin slipped to 3.9% in the most recent quarter, down from almost 7.5% in the same period last year.
It’s also a trend seen in other discount retailers. Most notably, rival Dollar General (NYSE:DG) suffered a gross margin contraction, suggesting the sacrifice of profitability for growth. However, it’s clear that the investor community does not appreciate this directive. Since the start of this year, DG stock has crumbled by more than 56%.
A Possible Staring Contest Ahead
To be fair, it’s possible that discount retailers like Dollar Tree could have their day soon. With inflation still stubbornly high and major corporations continuing to lay off their employees, consumers may need to bite the bullet. Part of that may involve shopping at dollar stores.
However, the segment may yield a staring contest. As stated earlier, it’s rather obvious that investors do not appreciate discount retailers’ margin-killing ways. At the same time, if one stops with the price cuts and/or promotions and the other does not, such a decision could lead to a competitive disadvantage. Thus, the crisis in the dollar stores may continue.
Is DLTR Stock a Buy, According to Analysts?
Turning to Wall Street, DLTR stock has a Moderate Buy consensus rating based on nine Buys, five Holds, and one Sell rating. The average DLTR stock price target is $156.07, implying 46.75% upside potential.
The Takeaway: DLTR Stock Veered the Wrong Way
At first glance, investing in a discount dollar store like Dollar Tree makes plenty of sense ahead of a recession. Essentially, hurting consumers will trade down to product offerings listed at the lowest price available. However, with its margins falling conspicuously, the company may have boxed itself into a corner, posing concerns for DLTR stock.
