Thread: How dollar stores ( $DG, $DLTR) make money
1/ Let’s start with a brief history of Dollar stores. Dollar chains were originated with DG) in 1955 and followed by Family Dollar (FDO) four years later. DLTR came to the scene in 1986. Interestingly, while DG and FDO have price points between $1-$10, DLTR still sticks to $1.
2/ DLTR was the best stock in 2008 and it was +64% when S&P 500 declined 38%. I heard people joking about seeing BMWs in front of DLTR stores back in 2008. During recession, people are forced to trade down even for daily necessities. Walmart (WMT) was also up by 20% in 2008.
3/ DLTR actually acquired FDO back in 2015 after a bidding war with DG. Despite DG’s higher offer, FDO’s shareholders decided to sell the company to DLTR because of antitrust concerns. Fortune published a fascinating article on the whole drama.
4/ However, given the bidding war and how things have turned out in last 5 years, DLTR shareholders perhaps consider FDO acquisition more of a “winner’s curse” at this point. You’ll see why as I delve into how DLTR makes money.
5/ DLTR stores are targeted at middle class bargain hunters and located near suburban locations while FDO stores are targeted at lower income people. Combined FDO and DLTR are similar in size to DG. Management thinks market can support 10K DLTR stores and 15K FDO stores. 
6/ Despite having the same business model, DG generates ~30% higher sales than FDO and looking at the recent growth trajectory, the difference between DG and FDO is widening.
7/ So what exactly does DLTR sell in its stores? Despite having similar product mix, FDO’s gross margin is ~500 bps less than DG in 2018. Moreover, while DLTR and DG had an incredibly stable margin in last 15 years, FDO margins continued to deteriorate.
8/DLTR’s EBIT margins have improved, DG’s are somewhat stable, and FDO’s margin are less than half of DG. I am sure DLTR management looked at the margin differential and found the acquisition of FDO to be a very tempting proposition, but by this time, they must have a sobering...
9/ ...realization how incredibly hard “turnaround stories” are. While DLTR and FDO have similar topline size, DLTR contributes ~75% of the consolidated company’s operating profit.
10/ Dollar chains are very high-quality business, as evidenced by pretty consistent and high ROIC. DG’s ROIC has consistently been hovering around ~40% in last 10 years. DLTR is also right up there, and FDO, of course, has always been a laggard even before DLTR’s acquisition.
11/DG’s sales and EBIT is only 12% and 18% higher than DLTR in 2018, but DG’s EV is ~60% higher. In fact, if you multiply DG’s EV/EBIT multiple of 21x by DLTR’s (excl. FDO) 2018 EBIT of 1.5 Bn, you reach $31.5 Bn of EV which is the current EV of DLTR. That means market valuing...
12/ ...at zero based on the current valuation.
In terms of shareholder return, as expected, DG has handily beaten both DLTR and the broader index in all time frame.
In terms of shareholder return, as expected, DG has handily beaten both DLTR and the broader index in all time frame.
