Why Credit Suisse Is Very Cautious on Dollar Stores

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Discount and dollar stores were a hot trend a few years ago, but one key analyst believes that this trend has run its course. Credit Suisse put both Dollar Tree, Inc. (NASDAQ: DLTR) and Dollar General Corp. (NYSE: DG) on the chopping block in its most recent report. 24/7 Wall St. has included some of the key highlights from this report and why Credit Suisse is growing cautious on each.

Credit Suisse upgraded Dollar Tree to a Neutral rating from Underperform and kept its $73 price target. The brokerage firm has been negative on the stock given concerns about the Family Dollar transaction. Challenges clearly remain, particularly given the deteriorating industry backdrop, as most industry participants seemingly need to invest to sustain share. However, Dollar Tree differentiates itself at this point by having the resources at its disposal to address its momentum in transaction synergies. It may be one of the few large-cap staples retailers to actually grow earnings in 2017.

However, the firm remained skeptical on Family Dollar. Family Dollar’s performance to date has disappointed. While synergies seem to be helping profitability, margins remain below levels achieved under prior management and comps have not improved. Credit Suisse believes more investment in price, store labor, and capital is needed to improve results, given years of underspending in this asset.

Shares of Dollar Tree were last trading at $74.22, with a consensus analyst price target of $89.43 and a 52-week trading range of $72.55 to $99.93.

Credit Suisse downgraded Dollar General to an Underperform rating from Neutral and lowered its price target to $62 from $69. In the firm’s view:

Dollar General’s long-term growth algorithm looks unachievable, as increasing competition and rising cost pressures should weigh on earnings for some time. While Q4 beat low expectations, the update highlighted underlying concerns related to sales momentum, margin sustainability, and the logic behind ramping openings to 1,000 stores per year. We believe Dollar General will ultimately be forced to reset expectations and disappoint a street consensus that has assumed a reacceleration to 10% annual growth after a flat 2017. We cut our rating to Underperform from Neutral and our target price to $62 from $69. We fine-tuned our 2018 and 2019 EPS estimates to $4.65/$5 (from $4.7/$5.05 respectively).

The company’s comps at mature stores turned negative and margins have declined, due in part to increased price competition. While management seemingly expects the environment to normalize after 2017, this is unlikely given competitors’ focus on food and consumables to drive traffic. The expansion of hard discount only exacerbates the problem over time. Credit Suisse believes that Dollar General will be forced to invest further in price to drive comps, resulting in weaker margins than expected.

Credit Suisse also noted that wage pressure is more acute for Dollar General given its large store base, low pay structure, and growth profile. Its focus on lowering store manager turnover below the current 30% level and the need to hire for accelerating new growth could be a multi-year expense headwind.

Shares of Dollar General were last trading down 2.5% at $68.93, with a consensus analyst price target of $79.32 and 52-week trading range of $66.50 to $96.88.