Our original thesis on DLTR was based on our view of a unique asset and the opportunity for growth in Dollar Tree, offset by Family Dollar continuing to drag on the overall performance. While sales at Family Dollar have turned positive in the last three quarters since we initiated, margins have deteriorated at both banners with higher merchandise and freight costs, an increased mix of consumables, higher shrink, and higher payroll costs. Although discrete closure costs should diminish, organic pressures are likely to remain (see page 5). Further, while initiatives such as expanding H2 stores, integrating distribution capabilities, and testing the multi-price point strategy at Dollar Tree could all lead to faster sales and higher returns, it is likely to take more time before these positively impact the earnings performance of the company. As such, we remain Peer Perform rated on DLTR with a CYE20 fair value of $110 (from our prior CYE19 fair value near $100).
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We had the opportunity to spend some time with both Dollar General (DG, Outperform, Target Price $165) and Tractor Supply (TSCO, Peer Perform, Fair Value $106) senior management teams (CEO, CFO and IR), as well as walk through the stores on Tuesday in Nashville.
We continue to view DG as a best-in-class operator with a strong long-term growth and earnings outlook. Indeed, as the company expands ongoing initiatives such as remerchandising non-consumables categories, expanding its cooler and fresh offering, investing in its distribution infrastructure, and rethinking/improving its distribution and in-store processes, our research suggests that growth could actually accelerate over the next few years. This idea is bolstered by our analysis showing significant white-space for new stores, as well as the growing appeal of the DG format across income demographics. Given Dollar General’s strong return profile and potential for accelerating growth, we view the company as a “must own” equity and are reiterating our Outperform rating, rolling forward and raising our CYE20 Target Price to $165 (From CYE19 Target Price of $142).
The Smucker’s team is waging a gallant fight to maintain growth both on the top and bottom-line. Indeed, the company has moved aggressively to gain exposure to faster growing categories like Pet, as well as launch new products/brands in its existing portfolio. The challenge, however, is the competitive climate remains elevated in most areas of its business, as much larger operators such as Nestle and General Mills invest behind competing brands in hopes of driving their growth algorithm. At the same time, retail giants like Walmart push to enhance private label offerings in Smucker’s core areas of peanut butter and jelly. Our research suggests that this environment likely will continue and, perhaps, even get worse. This, in our view, will pressure both top-line and bottom-line results and we are reiterating our Underperform rating.
Our Walmart CPG price tracker through last week shows a continuation of price cuts, especially in Food. Our Food basket is flat sequentially and down 1.1% y/y, while our HPC basket is down 0.3% sequentially and up 0.9% y/y. For U.S. based food companies, we continue to see risk around the pricing environment if Walmart reinstates a new round of price cuts.
While BJ’s 2Q19 came in ahead of our expectations, comparable sales of 1.6% continues to lag most of the company’s peers in the strongest consumer economy in a decade, which to us signals that the company still has significant work to do to improve the business. While management certainly has acknowledged that it will continue to work towards providing a better value proposition for its customers to drive memberships on multiple fronts, we do not see how this will be possible without a meaningful financial investment. BJ’s in currently on-pace for a fifth straight year of gross margin expansion, a rarity for a consumer staples retail company in a highly competitive environment, and our research indicates that it will need to at some point increase investments in order to drive sales growth. Relative to a year ago, the company seems to be making operational headway and is more derisked from both a financial leverage perspective and the equity exit from one of two financial sponsors.
Target’s ability to maintain its strong sales growth while delivering another quarter of profitability, with 32bps of gross margin expansion and 51bps of SG&A leverage, was certainly a surprise. It appears to us that TGT had (and likely still does have) spare capacity in its fixed and labor asset bases for incremental productivity. While on an “all-else-equal” basis, we continue to view a digital sale and carrying a lower margin than a pure in-store sale for an identical basket, Target’s performance appears to demonstrate that there is enough excess capacity in the store that the marginal revenue exceeds the marginal cost of the digital sale. Through 1H19, TGT has demonstrated not only that it could revitalize sales growth in its stores, but that it would be able to do so without deteriorating the cost and margin structure of its business. While there is potentially upside to both earnings and multiple expansion if results continue, we see the current equity price as adequately reflecting the growth potential and long-term risks, and we remain Peer Perform rated with a Fair Value near $105 (from low $80’s).
Topics this weekend…Target's Tidings - TGT 2Q19 Consumables Corner - BJ 2Q19 Hardline Happenings - HD 2Q19 and LOW 2Q19 Quote of the Week – Walmart, Inc. (WMT, Underperform, $105 PT) President and CEO, Walmart eCommerce U.S., Marc Lore on the 2Q20 Media Call
SPTN reported 2Q19 earnings on Wednesday 8/14 after the market close (preliminary headline results were released on 8/12). On 8/12, SPTN also announced a leadership transition, naming its former CEO (and current Chairman of the Board) Dennis Eidson as interim CEO (replacing Dave Staples). SPTN’s revenue and profitability growth remains subdued, while the pricing environment, in our opinion, is likely to get tougher before it gets better (see our Midweek Musings – Here We Go Again…). Supply chain costs continue to come in higher than anticipated and the Military business profitability continues to diminish. If the new leadership team at SPTN is able to address and overcome some of these challenges in the next few months, the company could see an improvement in its margin profile. That said, balancing the company-specific issues and a tough industry climate with a valuation that appears to be reasonable, we remain Peer Perform rated on the equity.
Walmart U.S. continues to impress, putting up a strong U.S. comp of 2.8% while leveraging operating expenses. The momentum the company has in the U.S. business allows it to further invest in its growth, whether through price and/or convenience. Our research suggests that this does appear to be the case, as the company seems to be implementing a fresh round of price investment (see our Midweek note Here We Go Again…), particularly in food. Taking a step back on why we remain Underperform rated, the overall company’s earnings and ROIC continues to be subdued by losses from international investments (Flipkart), and while it is still too early to tell, our research does suggest that Amazon’s move to one-day delivery and reacceleration in North America could lead to a potential slowing of sales for WMT, or necessitate further investments in distribution infrastructure. Coupling these risks with an equity that is trading well above its historic valuation leaves us Underperform rated, though we are raising our target price to $105. (from $95).
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