Feltl and Company Research Department 225 South Sixth Street, Suite 4200 Minneapolis, MN 55402 1.866.655.3431 Brent R. Rystrom [email protected] | 612.492.8810 Dollar Tree, Inc. Consumer- Retail Au gust 12, 2009 Company Description: Dollar Tree is the leading participant in the Extreme Value Retailing sector, one of the strongest sectors in the US retailing. DLTR operates over 3700 stores in 48 states, and is growing its units by 6% annually while delivering double-digit earnings growth. DLTR is based in Chesapeake, Virginia. Initiating Coverage (DLTR - $46.03) Strong Buy Key Points Financial Summary We are initiating research coverage of Dollar Tree with a Strong Buy rating and a $62 price target. Dollar Tree (DLTR) is the leading participant in the Extreme Value Retailing category. DLTR delivers strong unit growth, generally healthy same-store sales Rev(mil) 2008A 2009E 2010E results, compelling margins, and exceptional EPS growth and return on investment. Apr $1,051 $1,201A $1,281E In almost every one of these metrics, it outperforms almost all peers, both direct in Jul $1,093 $1,220A $1,320E the EVR category and in other major retailing sectors. Oct $1,114 $1,206E $1,311E Jan $1,387 $1,522E $1,662E DLTR operates one of the most profitable store concepts in retail. Its Dollar FY $4,645 $5,140E $5,573E Tree stores generate sales in excess of $1.3 million, contribution margins near P/Sales 0.90x 0.81x .83x $140,000, and earn about 100% annually on store-level investment. This generates substantial cash flows that easily fund operations while providing excess cash flows for other purposes. DLTR reported strong 2Q sales, a trend that should persist as consumers stretch spending by shopping at EVR retailers. DLTR has been one of the few EPS 2008A 2009E 2010E major retailers to report consistently strong same-store sales in this tough economic Apr $0.48 $0.66A $0.71E environment, reflecting both its appealing merchandise assortment and its ability to Jul $0.42 $0.56E $0.65E flex its offerings to favor consumable items. This flexibility will work to DLTR’s Oct $0.47 $0.51E $0.64E benefit as the economy recovers and relative strength returns to discretionary items. Jan $1.15 $1.28E $1.37E We estimate 2009 EPS of $3.02 and 2010 EPS of $3.38, but note DLTR’s strong FY $2.53 $3.02E $3.38E cash flows could be used in ways to drive long-term EPS higher. Our P/E 18.2x 15.2x 13.6x estimates are slightly higher than consensus expectations. We note that DLTR is going to generate excess cash flows that will likely average $200 to $300 million annually the next 3-5 years assuming unit growth rates are held steady. This excess cash could be used to fund accelerated growth, buy back significant amounts of stock, or fund growth in new areas (like Deal$), or some combination of all three. Price: $46.03 52-Week Range: $47.28 -$27.61 Our 12-month target price is $62, but upside to this could be substantial. Our Target: $62 Rating: STRONG BUY price target assumes that investors recognize DLTR as one of the premium retailers in the U.S., moving its multiple of 16.4 times current year EPS (average relative to Shares Outstanding: 90.5 mil peers) to 18.2 times next year’s EPS (a 10% premium to its peers). DLTR’s is Mkt. Capitalization: $4,166 mil arguably one of the most profitable retailers in the U.S., generating substantial Ave. Volume: 1,255,000 excess cash flow. If this excess cash flow was applied to simply repurchasing Instit. Ownership: 97% DLTR stock in the open market, we believe it would drive EPS up to 11% higher BV / Share: $14.16 Debt / Tot. Cap.: 17% than our 2010 EPS estimate of $3.38; a similar valuation metric would then value Est. LT EPS Growth: 15% DLTR at $69 a share. INVESTMENT RECOMMENDATION: Dollar Tree stores has performed extremely well through the difficult economic environment, and we believe its performance will continue strong as the economy recovers because of the flexibility of its store format and merchandise assortment. Our target price of $62 assumes substantial DLTR’s relative multiple moves from flat to a 10% premium relative to its peers. Our rating is Strong Buy. Please see important disclosures on pages 8 to 10. August 12, 2009 BUSINESS OVERVIEW: Dollar Tree should easily be considered the leading participant in the Extreme Value Retailing sector and one of the best performers in all sectors of retailing in the U.S. It is able to grow its units faster, generate better financial returns, and utilize the strongest balance sheet in the sector. It does this with a merchandise assortment that allows the company flexibility, a store-base that is visually appealing and pleasant to shop, a distribution system that is constantly gaining productivity, and a solid and seasoned management team. Unique Offering and Exceptional Value Dollar Tree’s stores offer a wide variety of merchandise categories: health and beauty aids, household cleaning supplies, housewares, food, beverages, toys, stationary, books, electronics, seasonal merchandise, and party supplies. DLTR is easily able to adjust its merchandise assortment to reflect economic and consumer trends. For example, it has increased its consumable assortment the past six or seven quarters to better position for retrenched consumers focused primarily on necessities. DLTR stores offer all items (or multiples of items) at just one price point: $1.00. And significant overseas merchandise sourcing provides competitive positioning of compelling products at exceptional value. Upscale EVR Environment DLTR’s stores are firmly positioned in the Extreme Value Retailing segment, but the company’s suburban real estate strategy and pleasing store environment drive a strong middle-class customer base. This includes an upscale and appealing décor, high-quality fixtures, and better lighting. In short, DLTR provides an EVR experience in an upscale setting, helping to attract a stronger customer base. DLTR works to make its stores convenient as well, and now takes debit cards, EBT, Visa, and Discover credit cards; these drive more traffic and higher average transaction sizes. Powerful Store Economic Model Dollar Tree’s stores deliver exceptional productivity. They average more than $1.3 million in sales and more than 170,000 customer visits per location. All stores are leased, so store-level investment is minimal, including net inventories of $100,000 ($140,000 before offsetting accounts payable) and capital investment (improvements and furniture, fixtures, and equipment) of $40,000. With contribution margins of 11% to 12%, store-level ROI is an near 100%, a level of profitability virtually unmatched in all of retailing. Strong Distribution and Support Dollar Tree has an excellent distribution system, with nine DCs supporting its nearly 4000 stores spread across the continental United States. In total, these DCs comprise 5.8 million square feet and in 2008 they shipped 160 million cartons of inventory. As DLTR as slowed its unit growth rate in recent years, operating and balance sheet leverage of the DCs has improved. Eight of the nine DCs are company-owned, and the ninth one, Salt Lake City, has a lease that expires in April2010. If DLTR chooses to let this lease expire and build a new facility, it would likely require a capital expenditure of $30-$40 million. Feltl and Company Research Department Dollar Tree, Inc. (DLTR) Page 2 August 12, 2009 Dollar Tree Distribution Center Overview Lease Square Location Own/Lease Expires Feet Chesapeake, Virginia Own N/A 400,000 Olive Branch, Mississippi Own N/A 425,000 Joliet, Illinois Own N/A 1,200,000 Stockton, California Own N/A 525,000 Briar Creek, Pennsylvania Own N/A 1,003,000 Savannah, Georgia Own N/A 603,000 Marietta, Oklahoma Own N/A 603,000 Salt Lake City, Utah Lease April 2010 385,000 Ridgefield, Washington Own N/A 665,000 Source: Dollar Tree 10-K dated January 31, 2009 MANAGEMENT: Bob Sasser, President and Chief Executive Officer. Mr. Sasser has been Chief Executive Officer since 2004 and President since 2001. Prior to that Mr. Sasser was the Chief Operating Officer from 1999 to 2004 and from 1997 to 1999 Mr. Sasser served as Senior Vice President of Merchandise and Marketing for Roses Stores. From 1994 to 1996 Mr. Sasser was the Vice President, General Merchandise Manager for Michaels Stores, Inc. Mr. Sasser has been on the Board of Directors since 2004. Kevin Wampler, Chief Financial Officer. Mr. Wampler joined Dollar Tree in December of 2008 in his current position as Chief Financial Officer. Prior to joining Dollar Tree, Mr. Wampler served as Executive Vice President, Chief Financial Officer and Assistant Secretary for The Finish Line, Inc. from October of 2003 to November of 2008. Mr. Wampler was with The Finish Line for 15 years serving in the positions of Senior Vice President, Chief Accounting Officer, and Assistant Secretary. Mr. Wampler was with Ernst and Young LLP from 1986 to 1993. Gary Philbin, Chief Operating Officer. Mr. Philbin has been with Dollar Tree since December of 2001 and has served as the Chief Operating officer since March of 2007. Prior to that Mr. Philbin served as the Senior Vice President of Stores. Before joining Dollar Tree Mr. Philbin was with Grand Union, a New Jersey based grocery store chain, where he held a number of positions including Chief Executive Officer. Prior to Grand Union Mr. Philbin was the Executive Vice President of Operations and Merchandising of Cub Foods from 1996-1997. Mr.