On Second Thought, Investors Like What Dollar Tree Had to Say

The company received two downgrades from analysts, but now the stock has found its equilibrium and is holding a 5% gain.

By Chris Markosh

via MarketBeat

This story originally appeared on MarketBeat

On the day after Dollar Tree (NASDAQ: DLTR) reported its fourth-quarter 2020 earnings report, the company received two downgrades from analysts. This came just a week after the company received a downgrade from Bank of America (NYSE: BAC). Generally speaking, downgrades are a bad sign because they indicate a lack of confidence from the institutional investment community.

However, in this case, the concern may be overblown. And that seems to be reflected in DLTR stock. The stock got a substantial post-earnings boost, then started to fall back. But it never crashed through a key support level at its 200-day moving average, and now the stock has found its equilibrium and is holding a 5% gain.

Sometimes Less Good Is Still Good

The two analyst firms to lower their price targets were Royal Bank of Canada (NYSE: RY) and BMO Capital Markets. In the case of Royal Bank, the DLTR price target went from $129 to $125. For BMO Capital Markets, the price target was lowered to $110 from $115.

However, the current stock price for DLTR stock is right around $101. That means if we take the lowest of the two price targets, DLTR stock could still have a 10% gain. That's why it's always important to look past the headline.

Grocery Sales Expected to Remain Strong

The National Retail Federation is forecasting that retail sales will grow at a rate of between 6.5% and 8.2% during 2021. And for the first time, online grocery sales are expected to exceed $100 billion. That means that Dollar Tree should have a large addressable market even as vaccines continue to roll out.

Combination Stores Are Off To a Good Start

As many of you know, Dollar Tree is also the parent company of the Family Dollar brand. In the fourth quarter, the company introduced the concept of the combination store. These stores are being established in small towns with populations between 3,000 and 4,000 where shopping options are limited. The two brands cater to roughly the same demographic, but in the combination, there will be distinct differences.

Both stores offer low prices, but neither is a "dollar store" in the strict sense of the word. And that will remain the case in the combination format. The Family Dollar part of the store is designed to meet the everyday needs of most shoppers. This will be where shoppers will be able to find meat, frozen items, and even some produce. The Dollar Tree section will contain seasonal items including holiday decorations. Most of these items will be priced at just $1.

This is also the area of the store that has room set aside for Crafter's Square. Investors saw recently how well the crafting sector has done during the pandemic.

There are currently only 50 such stores throughout the United States. However, Dollar Tree says they are planning on adding more stores during 2021.

In addition to adding more combination stores, Dollar Tree plans to add more of its Dollar Tree Plus stores from 120 to 500 locations. These stores contain add items priced at $3 and $5.

Dollar Tree Stock May Be the Best of the Discount Bunch

In the last 12 months, DLTR stock is up 30%. That's better than both Big Lots (NYSE:BIG) at 26.5% and Dollar General (NYSE:DG) at 13%. The P/E ratios for Dollar Tree and Dollar General are nearly identical. And while some would point to Dollar General's dividend, my MarketBeat colleague Thomas Hughes wrote in October, "Dollar General pays a dividend where Dollar Tree doesn't, true, but it's less than 1% and the growth outlook isn't as positive."

In August, I compared Dollar General and Dollar Tree. At the time, I gave DG stock the nod because the company looked prime to post great earnings and already had the footprint that Dollar Tree was trying to build. However, I can now see that Dollar Tree's growth strategy may be just the thing DLTR stock needs to excite investors as the category may post slower growth in the second half of the year.

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