Dollarama Stock: Hide Here While Inflation Persists


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Presentation of the company and thesis

Dollarama Inc., (DOL: CA) (OTCPK: DLMAF), headquartered in Montreal, is Canada’s largest discount dollar store chain, with more than 1,400 stores nationwide. The company offers more than 4,000 products to consumers at a price cap of $4 per item – although this will increase to $5 over the next year. The company also owns a 50.1% majority stake in Dollar City, a Latin American brand of dollar discount stores. I think there is some upside potential in the stock given the current macro headwinds. The company continues to navigate an inflationary environment and previously announced price increases should help offset this pressure.

Management has done a tremendous job leading the company and has seen stock appreciation consistently outpace the broader Canadian market over the past half-decade. DOL reported better-than-expected earnings in early June and has seen the stock rise 5% in the past six weeks. The business remained resilient throughout the first half of the year, growing more than 20%, while the broader Canadian market was negative. DOL consistently exceeds estimates and has been a quiet leader in the Canadian retail landscape since its IPO in 2009.

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The company has also announced clear ESG objectives and initiatives, which will start to be a priority in the near future. It pays to be careful when buying the stock, as other big competitors such as Walmart, Dollar Tree, Giant Tiger and Circle K (Couche-Tard) have complex merchandising strategies (i.e. i.e. promotions, loyalty/points schemes) to drive in-store traffic. DOL also has regional competitors, such as 99 Cent Depot, and sports a strong valuation with a current P/E of around 30. Nevertheless, DOL remains a good choice as inflation remains high. I initiate a conservative buy with an 18-month view of $82/share, with a 27 P/E to EPS ratio of $3.00 in CY2023, with an EPS estimate of $2.71 in CY2022.

Competitive Adv

Dollarama – Q1 Investor Presentation

DOL outlook and ESG focus

DOL released strong first-quarter numbers in June, highlights of which included same-store sales growth of 7.3% and EBITDA of $300 million, while reiterating full-year guidance. The company opened ten new stores and repurchased 1.4 million shares. These updates were well received by the market and the company continued to make progress in the first half of 2022. DOL’s margins dragged 200 basis points to 42.1% as consumables became a part most important part of the sales mix. Management noted that inventory will be scaled back by the end of the year, and given the small reduction, I believe they will hit their targets. Neil Rossy, CEO, stressed on the first quarter conference call that “the situation will normalize and we do not expect to miss a season” regarding the sale of inventory.

DOL’s efficient operating processes continue to improve, as evidenced by their cash conversion cycle dropping to 79 days, meaning DOL takes 79 days to convert inventory to cash. In recent years, this number has been on a downward trend, indicating improved efficiency. This trend was reinforced by a 14% increase in in-store traffic, which better represents the DOL brand in relation to online sales. The company remains somewhat heavily leveraged at 2.74x 2022 net debt/EBITDA, but with an improving sales picture, it is poised to continue to succeed both operationally and in the eyes of investors.

DOL also has a presence in Latin America, through a majority stake in Dollar City. Although the entity’s earnings are not material to the balance sheet, at just $8.7 million in the first quarter, the owners have a trigger put option that exercises this year, meaning DOL has the ability to buy more of the company. Dollar City has several hundred stores in El Salvador, Guatemala, Colombia and Peru, and management has the opportunity to understand a consumer accustomed to high inflation and more defined product lines. With the BOC chief confirming that inflation will remain above 7% this year, DOL has an opportunity to outperform its peers and improve its inventory mix in the second half of the year. Their forecast for 60 to 70 net new stores in CY2022 remains intact, and Dollar City should increase its store target, according to CIBC.

CIBC Dollarama Review

CIBC Equity Research – Q1 Review

Management has been a key bright spot for DOL and an example of this has been communicating ESG objectives to investors. Last year, the DOL set a target of reducing emissions by 25% by 2030 compared to 2019 baseline figures. Although not as ambitious as other large companies, given DOL’s retail scale in Canada, a vast and expansive country with a concentrated population, these goals seem reasonable and achievable. In June, DOL provided a full update on their progress. DOL recorded a higher year-over-year recovery rate of waste materials at the store level, with 77% of recovered materials diverted from landfills and announced a commitment to maintain at least 40% female representation at the management level. The company also detailed where and how emissions were generated, and outlined a key step-by-step process to achieve its metrics, proving that this initiative was not greenwashing. Through efficient and consistent operations and leadership in macro-topics, management continued to demonstrate leadership and remained nimble during this unprecedented time.

Industry & Risks

Walmart (WMT), a bellwether for the US economy, announced updated forecasts on July 25, 2022, which saw the company cut its expected profit over the coming year in the face of persistent inflation. . Although not a direct comparison to DOL, the indications were intriguing because, although negative, they provided a clearer short-term picture of the “trade dip” phenomenon and the composition of sales of one of the largest retailers in the world. Over the long term, the discount retail channel is expected to grow at a CAGR of 4.4%. Barclays noted on June 9, 2022 that the DOL had seen the strength of the consumer move lower and that by maintaining its forecast, it was likely to beat expectations. Unemployment insurance claims recently hit an 8-month high, which also reinforces the idea that consumers will continue to remain cost-conscious.

Tendencies

Barclays Equity Research – Q1

Walmart also noted that consumables were becoming a larger share of the sales mix, while apparel and electronics would lag throughout the year. Target (TGT) has also cut its forecast recently, emphasizing an inventory mismatch, while Dollar Tree (DLTR) posted strong numbers in May but warned they needed to scale inventory for the second. half of 2022. Although DOL does not have fresh food inventory like Walmart or Target, they do have non-perishable consumables that have a shelf life like beans, chips, and candies. The company’s non-perishable section also includes smaller travel accessories, including cosmetics, luggage tags and neck pillows, which were highlighted as a strength during the quarter. All in all, given the type of consumables that DOL sells, their proven success in inventory management, and the fact that they are a low-priced brand, there are tailwinds to infer that DOL will continue to outperform its peers in the short to medium term.

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DOL Q1 Investor Platform

As with any retailer, there are inherent risks in the business that cannot be fully mitigated. Chief among them for DOL is cost-effective inventory and supply chain risk management. The ability to provide quality merchandise at low prices is subject to several factors beyond DOL’s control, including commodity costs, currency fluctuations and shipping costs. For a company whose main differentiator is price, it will be interesting to see if customers balk at the new $5 price for certain products. The business may also be affected by outbreaks of COVID-19, which may impact in-person traffic. Although the company has an online site, the brand is known as a retailer and the competition for online sales is fierce compared to their well-positioned outlets. DOL is also highly indebted, with net debt of nearly $1.9 billion. Although the company has mostly fixed rate debt, the ability to refinance at a cheaper rate will likely not be possible in the near future. DOL has more than $70 million in cash, but to get its stores growing again, they may need to raise capital.

Model – Fairly rated with some pluses

DOL saw strong growth in the first half of the year, boosted by strong quarterly results and the expectation that customers will continue to turn to discount retailers in the face of high inflation. Although the company’s net cash position has fallen given management’s interest in share buybacks, the company has sufficient cash balances to fund current growth plans. The model predicts a WACC of 6.2%. With rates rising, I expect the cost of the hike to exceed 5% if they attempt to take advantage of this environment, given that their previous fixed rate debt is between 1.5% and 3 .6%.

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Author – WACC Forecast

I expect $26.4 billion in continued value, given revenue growth of 14% this year and mixed revenue growth of around 6.5% for three years, sales growth of comparable stores continuing to impress. I see margins ending up near the top of the forecast, at 43.7%, for the year. I maintain that other cost ratios are mostly on par with guidance as they were conservative given the strong first quarter numbers. Given an estimate of share buybacks, a stock price of $82 (see below) may be supported by fundamentals. The stock price is supported by a 27 P/E to EPS ratio of $3.00 in CY2023, with an EPS estimate of $2.71 in CY2022. This value presents an EV/EBITDA ratio of 22.1, in line with industry peers and analyst estimates. In today’s price target, I estimate shares outstanding at 290MM, down from 294MM in Q1, as DOL repurchased 1.4MM of shares last quarter, and continues to focus on this initiative.

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Author – NOPLAT

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Author – EV Calculation

DOL remains Canada’s leading discount retailer and should benefit from high inflation. The company sports robust operations and continues to expand in South America. Although quite valued, I think DOL is worth a cautious buy, and their performance over the past decade is reassuring.

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