Wells Fargo reiterated an Outperform rating on Dollar Tree based on its view of upside potential to the model related to the Family Dollar merger, and recent external factors (gas prices, foreign exchange) that work in the company’s favor. The investment bank also moved up the valuation range to $91 to $96 from $87 to $95.
The investment bank also published its new Dollar Tree estimates of $3.34 and $4.56 for fiscal 2015 and fiscal 2016, respectively. In Wells Fargo’s opinion, Dollar Tree’s shares offer the relative stability of consumer staples exposure, at a lower multiple, with better growth.
Also in its report Wells Fargo detailed how diesel prices and China could affect Dollar Tree:
Diesel prices are down $0.35 (12%) since Dollar Tree provided guidance in May, which should help offset ongoing freight inflation related to rationalization in the trucking industry, which impacted GM by approximately 30-40 basis points in recent quarters. Over time, the devaluation of the Chinese yuan could also benefit Dollar Tree as Chinese goods become cheaper in U.S. dollars, and Dollar Tree has a more flexible merchandising model than most retailers given its fixed $1 price point and ever-changing discretionary mix (this could benefit comps and /or gross margin). We note DLTR has said approximately 40% of its product comes from outside of the U.S., mostly from China.
The company has tough comps in the second half of 2015, but easy compares for Family Dollar embedded in the combined income statement are underappreciated. Family Dollar’s gross margin in the fiscal fourth quarter of 2014 was lower than expected due to major price investments on over 1,000 basic items, a strong mix effect towards consumables, and less benefit from shrink and markdowns than expected. The company also noted in the fiscal first quarter of 2015 that operating expense growth was greater than expected, primarily due to higher workers comp costs.
Wells Fargo gave its investment thesis as:
Within the sector, Dollar Tree offers among the highest top-line growth in mid/large-cap retail, and a differentiated fixed price concept with significantly lower prices than anyone in the channel. We still see room for continued top-line momentum, and we expect gross margins to stabilize.
Shares of Dollar Tree were up 4% at $76.07 on Wednesday afternoon. The stock has a consensus analyst price target of $85.77 and a 52-week trading range of $53.17 to $84.22.
Family Dollar shares were relatively flat at $79.39 on its 52-week trading range of $59.81 to $80.97. The stock has a consensus analyst price target of $74.21.