Thrifty Products Stoke This Cheap Stock’s Profits

How many times have you walked through the aisles of your local grocery store and mindlessly grabbed items off the shelf that are staples of your home? Things like spaghetti sauce, dish soap, shampoo, paper towels… the little necessities life requires.

How many times have you plucked them off the shelf and, somewhere in the back of your mind, wondered if there wasn’t some way to get this particular item a lot cheaper? After all, when you shop at a grocery store, you’re paying retail — regardless of whether you are a member of the store’s discount program or not.

You might be shocked to learn that Dollar Tree Stores (Nasdaq: DLTR) carry many of the aforementioned items for exactly one dollar. No more, no less. You may be skeptical about believing a shopper can find something just as good at Dollar Tree as in a major grocery chain. After all, the last dollar store I visited, some ten years ago, proved to be a lackluster experience. The store carried cheap knock-offs of all the important household items, ones that failed to even meet discounted expectations. The paper towels were like sandpaper. The dish soap seemed like water with a green crayon dipped in it.

A recent trip to a local Dollar Tree, however, upended this impression. In truth, Dollar Tree carries brand-name items in slightly smaller containers, and at far cheaper absolute and relative prices than the grocery store. Savings were anywhere from $2 to $6 per item. Those numbers add up, particularly during a recession. Selections are both traditional and seasonal, and the company has even added freezers and refrigerators to 40% of its store base during the past few years.

Dollar Tree leases more than 3,800 stores in the United States. Management is also opportunistic — they’ll scoop up retail space from other retailers who file for bankruptcy. One might expect the worsening commercial real estate market to provide plenty of opportunity for management going forward.

The company is operating like clockwork, with a strong distribution infrastructure, well-located storefronts and a commitment to a strong balance sheet. Almost every important financial metric has been improving at Dollar Tree for the past several years. In the past four years, net sales grew +54% and now stand at $5.2 billion (+12% growth this past year). Gross profit grew from $1.17 billion to $1.86 billion, a +58% increase. Meanwhile, net income has almost doubled from $174 million to $320 million, which includes an incredible +32% increase this past year alone.

These figures speak to the power of Dollar Tree’s business model in a recession. People are skittish about spending money, and perhaps they are learning that there are big savings to be had at Dollar Tree stores.

Dollar Tree’s impressive growth is notable particularly when considering its enormous store base. There is plenty of room for more stores across the country, and Dollar Tree keeps adding them with no signs of market saturation.

At this point, in order to evaluate Dollar Tree as an investment, it is prudent to look at future growth potential, its current balance sheet and its valuation relative to peers. Analysts are predicting +19% growth this year and +12% annually during the next five years. The company’s current PEG ratio is 0.70 for this year, suggesting it is significantly undervalued. It’s 5-year PEG comes in a little over 1.0, which doesn’t tip the value proposition far enough out of whack to dismiss it.

This is especially true when considering the company’s $350 million in net cash (about $4.50 per share) and free cash flow in excess of $400 million. This is an extremely healthy company, which investors should marvel at, considering the heavy sector competition, and net profit margins of only 6%.

As for the competition, Dollar has it beat. Family Dollar Stores (NYSE: FDO) has the same market cap, yet employs twice as many people and is only showing +5% revenue growth. Dollar General Corporation (NYSE: DG) is almost twice as big in market cap, and plods along with six times more employees, lower gross and net margins, and yet has the same net income as Dollar Tree.

You can’t buy a share of Dollar Tree for a buck these days, but you could still make a buck or two on the stock. Dollar Tree Stores seems like a solid play in good times and bad.