Equity Research Consumer Discretionary Dollarama Inc. (DOL‐T) Strong Top Line and Margin Growth Merits A Higher Valuation Stock Rating: Buy Investment Summary 12‐Month Price Target: C$113.49 ■ Solid Revenue Growth Driven by Consistent Store Openings: DOL currently has 1,069 locations and it has provided guidance to expand its footprint to 1,400 stores. We expect Current Price DOL to reach its store count target by end of FY2022 assuming an average of 65 stores (02/16/2017): C$102.08 opening per annum. This should continue to support its robust revenue growth (CAGR of 13.3% FY11 – FY16). We are projecting DOL to grow its sales by 10.4% CAGR into FY2022 Implied Return: 11.2% and maintain a SSSG of 5.0% into FY2019 (and 4.5%/4.0% after). ■ Best‐In‐Class Operational Performance Remains Intact: DOL’s roll‐out of debit payment system, coupled with the gradual introduction of higher price‐point items have been largely favored by consumers as shown in its resilient average basket size growth. DOL’s operational strategy has proved to bode well for the business and this is reflected Trading Data in its continued improvement in Gross Margin (from 37.5% in FY12 to 39.0% in FY16) and Market Cap (Mil): C$11,854 Operating Margin (from 16% in FY12 to 21% in FY16). Enterprise Value (Mil): C$13,041 Shares O/S (Mil): 116.4 ■ Strong Financials Continue to Support Shareholder Return: In addition to its resilient 52‐week High: C$104.94 revenue growth and operational performance, DOL has been able to generate consistent 52‐week Low: C$74.38 EBITDA (CAGR of 24% FY11 – FY16, and 22% EBITDA margin for FY2016), which allows the Fiscal Year End: January firm to produce robust free cash flows and distribute most/all of them to shareholders Current Quarter: Q4 2017 through share repurchases and dividends. Dividend Yield: 0.39% ■ Our $113.49 target price is based on a FY2018 EV / EBITDA multiple of 17.5x and a FY2018 P/E multiple of 25.0x, vs. median peer company multiples of 9.7x and 16.0x, EPS FY2016A FY2017E FY2018E respectively. Given DOL’s superior performance in EBITDA growth and margins, we Q1: 0.50 0.68 0.81 Q2: 0.74 0.88 1.06 believe that the company continues to warrant premium multiples relative to its Q3: 0.78 0.92 1.12 competitors. In addition to our estimated FY2018 multiples, a DCF analysis with our long‐ Q4: 0.99 1.06 1.31 term FCF projections, a discount rate of 6.1%, and a Terminal FCF growth rate of 2.5% produces an implied share price that falls in the range of $104.30 to $120.46. DOL Share Price ■ The Bottom Line: In our view, DOL remains a compelling long‐term investment 110.0 underpinned by its dominant footprint in Canada, strong organic growth achieved 100.0 through operational excellence, and sound fundamentals. However, given the 90.0 heightened expectation from DOL’s operational excellence and its ability to deliver 80.0 shareholder return historically, we do not rule out a temporary pullback in share price 70.0 (refer to Q3 FY2016 earnings) should Q4 FY17 earnings come in less than / marginally 60.0 beating the street consensus. 11‐Feb‐16 11‐May‐16 11‐Aug‐16 11‐Nov‐16 11‐Feb‐17 Financial and Valuation metrics FY2016A FY2017E FY2018E Company Description: Revenue ($Mil): 2,650.3 2,961.0 3,311.3 Dollarama is the largest dollar store chain in Canada, EBITDA ($Mil): 597.5 675.4 763.4 operating more than 1,050 locations averaging 8,500 EV/EBITDA ($Mil): 21.8x 19.3x 17.1x selling square feet in every province in Canada. The Lease‐adjusted Debt ($Mil) 1,851.2 1,948.4 2,050.8 company sells a mix of general merchandise, seasonal EBITDAR ($Mil) 752.5 846.0 951.0 goods and consumables. Its product is typically Lease‐adjusted Debt/EBITDAR 2.5x 2.3x 2.2x offered at prices less than $4. P/E: 34.0x 28.8x 24.1x EPS ($): 3.00 3.54 4.31 Henry Ye, [email protected] 1 Solid Revenue Growth Driven by Consistent Store Openings DOL currently operates 1,069 locations in every province in Canada, representing over 50% of the industry’s market share. Management has been able to execute well on strategically opening ~75 new stores/year on average and deliver a 5-year top-line CAGR of 13.3% since 2011. DOL has provided guidance to expand its footprint to 1,400 stores and we expect DOL to reach its store count target by end of FY2022, assuming an average of 65 new stores will be added per annum (~5% annual footprint growth). This would represent a 5-year top-and bottom-line CAGR of 10.4% and 11.5% going into FY2022, respectively. In addition, while DOL will likely remain focused on expanding its footprint in ON and QC, we expect the firm to penetrate further into Western Canada over time (i.e.: AB & BC) underpinned by the region’s robust spending power (AB & BC represent over 1/3 of Canada’s GDP; Appendix 4). These factors, in our view, should continue to support strong sales growth and steady SSSG. SSSG by Basket and Traffic (%) and Sales (C$mil) Same Store Avg Transaction Growth (Traffic): 15.0% 800.0 Same Store Avg Transaction Size Growth (Basket): 700.0 Sales (RHS) 10.0% 600.0 8.5% 7.9% 7.9% 6.9% 6.6% 500.0 6.2% 4.8% 5.9% 6.4% 5.1% 5.7% 5.0% 3.7% 1.1% 4.2% 400.0 3.3% 300.0 0.0% 200.0 100.0 -5.0% - Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2014 2014 2014 2014 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 Source: Company reports Best-In-Class Operational Performance Remains Intact DOL’s roll-out of debit payment system, coupled with the gradual introduction of higher price-point items have been largely favored by consumers as shown in its resilient average transaction size growth. Since the introduction of debit payment in Q3 FY2009, transactions via this manner have grown from 30% to close to 50%, and the average transaction size for debit card sales has been consistently over 2x than cash sales. To capitalize on the higher transaction size from the debit payment channel, DOL introduced the multiple price-point strategy which provides flexibility to DOL’s merchandising options, protection from higher input costs, and hedge against inflation. In addition, DOL is about 11 months into its credit card pilot program in BC, we believe a national implementation will roll out sometime in Q1 FY2018. The addition of this alternative will likely be favored by younger customers, albeit it is still early to attest the potential top-and bottom-line impact for FY2018 and onwards. Sales % by Payment Method 80.0% 70.0% Q3 FY2013: Debit Cash $2.50/$3.00 price 70.0% points introduced 60.0% Q1 FY2010: 51.3% $1.25/$1.50/$2.00 50.0% price points introduced 48.7% 40.0% Q1/Q2 FY2017: $$3.50/$4.00 price 30.0% points introduced 30.0% 20.0% FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 Q1 2017 Q2 2017 Q3 2017 Source: Company reports 2 In addition, DOL’s operational strategy has proved to bode well for the business and this is reflected in the continued improvement in its Gross Margin (from 37.5% in FY12 to 39.0% in FY16) and Operating Margin (from 16% in FY12 to 21% in FY16). Looking ahead, we remain convinced that DOL could sustain a gross margin rate of 38 – 39% and deliver operating margins in the range of 20 to 22%. Strong Financials Continue to Support Shareholder Return In addition to its resilient revenue growth and operational performance, DOL has been able to generate consistent EBITDA (CAGR of 24% FY11 – FY16, and 22% EBITDA margin for FY2016), which allows the firm to produce robust free cash flows and distribute most/all of them to shareholders through share repurchases and dividends. In fact, DOL’s free cash flow has grown from $120 mil in FY2012 to over $360 mil in FY2016, and management has gone above and beyond to return over 100% of the firm’s FCF since FY2013 through debt financing. We believe the management will gradually normalize its aggressive approach in share purchases while maintaining its pace in raising its dividend/share by $0.04 per annum. FCF & Shareholder Return 700.0 200.0% 180.0% 600.0 160.0% 500.0 140.0% 120.0% 400.0 100.0% 300.0 80.0% 200.0 60.0% 40.0% 100.0 20.0% - 0.0% FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017E FY 2018E Free Cash Flow Dividend Share Repurchases Dividends + Shares Repo as a % of FCF (RHS) Source: Company reports Further, the combination of improved EBITDA margins and reduction of capital structure via buyback has resulted in higher return from DOL’s invested capital than its peers (31% vs. peer average of 14%). Considering the mild competition in Canada (closest competitor, Dollar Tree, only owns ~20% as many as DOL’s retail locations) and future store growth prospect, we believe DOL is well positioned to gain a higher market share (+55% currently) and maintain a similar level for its return metrics moving forward.