Dollarama: why I’m ignoring the nepotism and related party transactions

While I don’t think that Dollarama is extremely compelling at the current P/E of 26.5, I do own the stock because I am trying to diversify.  The company’s earnings growth is impressive and I like the new CEO, even though his father passed on the family business in 2016.  And while the related party transactions continue under Neil Rossy, they haven’t meaningfully impacted shareholder returns in the past two decades.

Dollarama explained

While Dollarama competes directly with dollar stores, it is more of a discounter than a dollar store.  Dollarama snipes at most of the retail landscape:

  • Convenience stores.  While Dollarama has a narrower selection (e.g. only 1 energy drink), Dollarama has lower prices and slightly longer lines.  Dollarama is a great place to buy soda, candy, chips, and snacks.
  • Grand & Toy, a retailer that focuses on office supplies.  Dollarama undercuts Grand & Toy on the basics- pens, school supplies, etc.  However, the Dollarama line-up is extremely limited.
  • Apparel stores.  Dollarama only sells garments that don’t have sizes like socks, hats, etc.  Because most garments have sizes, their inventory turns are very low and therefore their margins must be high.  Dollarama merely goes after the most attractive items that apparel stores sell- seasonal items like winter hats and gloves, clothing that doesn’t have sizes, etc.
  • Supermarkets.  Dollarama sells cleaning supplies, kitchen utensils, canned food, foods with long shelf life, etc.
  • Wal-Mart.  See supermarkets.
  • Best Buy and other electronics retailers.  Dollarama sells cables, adapters, and batteries.  Dollarama doesn’t sell computers, music players, headphones, etc.
  • Drug stores.  Dollarama sells pregnancy tests for $1.25 rather than the ~$7 that Shoppers Drug Mart charges.
  • Toy stores.  Dollarama sells low-quality toys at low price points.

As a shopper, I try to go to Dollarama first to see if I can buy what I need.  Typically, Dollarama has much lower prices than everybody else.  Sometimes my Dollarama trip is unsuccessful:

  1. Dollarama may not have that particular item.  This is the nuisance of shopping at Dollarama.  I cannot go online and look at a store’s inventory (unlike, say, Canada Computers or Best Buy).  Once I arrive at Dollarama, it’s not obvious as to what aisle the item would be.  Shopping at Dollarama is confusing.  There are no obvious patterns (to the shopper) as to what they Dollarama does and doesn’t sell.  There is no advance warning as to what SKUs are removed from Dollarama’s lineup.  It’s not obvious that Dollarama sells pregnancy tests.
  2. Dollarama sells cheap crap (from China) and I would rather buy something that is higher quality.  Dollarama is getting better at this as Dollarama shifts towards items that are better value (a better balance of quality and price).  Dollarama is a mix of low and high-quality items.

Afterwards, I will go to a pricier retailer if I cannot find a suitable item at Dollarama.

While Dollarama has obvious appeal for low-income shoppers, many high-income shoppers (e.g. housewives) do frequent Dollarama because of the deals.  Dollarama doesn’t skew towards low-income in the same way that Wal-Mart does.  I don’t believe that any shopper cares about the dollar store gimmick (e.g. items priced in round increments of $1 / $2), so I think that investors can ignore all of the noise surrounding Dollarama moving into new price points.  The shopper does not care.

Dollarama is slightly more efficient than other retailers because it doesn’t run sales.  It doesn’t have to move items around the store as sales come and go.  It also avoids the labour costs of constantly changing prices.  Everything at Dollarama is “on sale” all the time.

Is the son as brilliant as his father?

In 2016, Larry passed on the CEO position to his son Neil.  The pair seem to have notable differences in the way that they run Dollarama.  The most obvious difference is that Neil isn’t allergic to technology.  Dollarama did not implement point-of-sale terminals until 2011.  (See my post “Dollarama: The low-tech retailer that could“.)  At the beginning of 2016, Dollarama began trials of credit cards while Larry was announced as the new CEO that year.  Now, Dollarama accepts credit cards in all stores and is expected to roll out online shopping this year.

Granted, it’s unclear to me as to the appropriate level of technology.  Retailers like Target (and Abercrombie) show the danger of too much high technology (Target’s disastrous Canadian expansion was crippled with technology that didn’t work, leading to empty shelves).  Wal-Mart has wasted money on failed technologies such as RFID.  However, it does seem reasonable for Dollarama to move away from the extreme of having very little technology.  Now that all of Dollarama’s suppliers have been strong-armed into putting barcodes on their products, Dollarama can re-supply its stores better and spend less time manually counting its inventory.

Merchandising

Dollarama continues to innovate its business model by moving into new markets such as apparel.

However, Dollarama may have stumbled a little in:

  1. Raising prices, e.g. on branded candy.  The discount between Dollarama and supermarkets has narrowed.
  2. Offering items that don’t undercut the competition.  Tostitos chips are $3 at Dollarama and $3 at No Frills (the discount supermarket chain owned by publicly-traded Loblaws).  Off-brand equivalents at No Frills are cheaper than buying Tostitos at Dollarama.  It’s kind of like walking into an outlet store and seeing a full-price item on store shelves.  (EDIT 10/31/2018: Some time ago Dollarama lowered the price to $2.50, roughly fifty cents cheaper than the discount No Frills chain.)

Nowadays when I shop at Dollarama, I can’t simply blindly assume that everything at Dollarama is a good deal.  A few of the items are clearly at parity with other major retail chains.  This makes shopping at Dollarama more taxing as I have to memorize competitors’ pricing.  I’m not too worried about this right now as it seems that management is aware of the problem.  From the latest Q2 earnings call:

[Neil Rossy] The Q2 SSS growth rate primarily reflects our decision to limit price increases in order to deliver an even more compelling value proposition for customers, a key factor in our long-term success. We also faced a difficult comp.

Little things that probably don’t matter

Dollarama’s private label products (e.g. items that don’t disclose Dollarama’s supplier) look great now.  This should help sales because the house brands don’t look like the off-brand items that you might see at supermarkets like No Frills.  Dollarama’s private label products typically don’t look off-brand.

True North seems to be a Dollarama brand as it does not list the supplier and has Dollarama’s price on it. Sorry about the glare in the photo.

The packaging is helpful as any products that happen to be gluten-free are labelled as such.

The store layouts are getting better.  Shoppers have to walk through an “isle of temptation” full of candy and snacks when they checkout, which should increase impulse purchases (Shopper’s and Marshalls are other stores that do this).  Some stores are now stacking inventory on top of shelves, much like Costco or Home Depot.  This utilizes the store’s real estate a little better.

On the other hand, the cash checkout could be revamped because the lack of desk space slows down the checkout process.  The next shopper can’t give their items to the cashier when the last customer still has their bags on the checkout area. While Shopper’s Drug Mart has a similarly cramped checkout layout in some stores, they don’t have this problem as much because Shopper’s doesn’t have as many customers.  That being said, Dollarama’s cashier efficiency has to be far superior to competitors as Dollarama employees constantly switch between cash and restocking.  Unlike convenience stores, the cashiers spend very little time idling and waiting for customers to show up.

Dollarama’s numbers are incredible

In 2013, I wrote about dollar stores.  In that post, I calculated the following as a rough proxy of ROIC (return on invested capital):

Annual Operating Profit / (Property & Equipment + Inventory)

These were the results:

  1. DOL:CN – 57.8%
  2. DLTR – 47.6%
  3. DG – 36.90%
  4. FDO – 23.5%

Since then, DOL’s return went from 57.8% to 68.5% in YE2016.  Neil Rossy became CEO later on in 2016 and the numbers have become even better, going up to 76.9% in YE2018 from 68.5%.  (Google Sheet calculations.)  These numbers are phenomenal.

In comparison, here’s what happened to Dollarama’s retail peers:

  1. DOL:CN – 76.9%
  2. DLTR – 31.4% (*These numbers are diluted by the FDO/DLTR merger.)
  3. DG – 31.8%
  4. COST – 14.7%
  5. FDO (2014) – 12.8%
  6. WMT – 8.9%

Both Dollar General and Family Dollar have lost some of their shine since 2013, while Dollarama continues to get better.  And while Wal-Mart has respectable numbers, Dollarama’s numbers look ludicrous in comparison.

Comparable store sales

Dollarama’s stock has tanked recently after putting up 2 quarters of “weak” same store sales- 2.6% in Q1 and Q2.

Perhaps the stock market has over-reacted.  Dollarama is facing some headwinds in Ontario due to the minimum wage hike.  Despite the headwinds, 2.6% is a fairly reasonable comp.  Management is currently guiding to a fairly healthy 2.5%-3.5% SSS comp.

Based on the results of first 6 months, and in light of decision to hold back in price increases, we are setting our assumption for full year same-store sales at a range of 2.5% to 3.5%, down from the previous range 4% to 5%. Despite a more conservative sales forecast, we are increasing gross margin guidance by 50 basis points to a range of 38.5 to 39.5 of sales.

While the recent deceleration in comparable sales is mildly negative, I see more positive trends happening at Dollarama than negative trends.  If you believe that return on capital is just as important as comparable store sales, then the trend looks quite positive for Dollarama.

*Disclosure:  Long Dollarama.  I bought before earnings came out so I am underwater on my position.

 

Links

Some members of FinTwit are bullish about Dollarama (notably @BluegrassCap) while others are bearish (@Keubiko).

Dollar stores and Dollar Tree (DLTR)

A post discussing Dollarama’s related party transactions.

Dollarama: The low-tech retailer that could

6 thoughts on “Dollarama: why I’m ignoring the nepotism and related party transactions

    • I feel like the answer is no. Look at it this way. A company has two options:
      A- Own its own real estate.
      B- Rent/lease real estate.
      Option B generally provides higher returns on capital. We’re fine if the calculation “punishes” retailers for owning their real estate.

      #2 – Now is this the right model for looking at businesses? Maybe… or maybe not. What we actually care about is the ability of the business to invest capital at high returns. A dying software business might have a high ROIC but have no way of growing earnings. So we should be wary of retailers that have completely saturated its home country with stores and so on and so forth. Earnings growth (as well as operating income growth and FCF growth) is a helpful backwards-looking metric for that.

  1. “While I don’t think that Dollarama is extremely compelling at the current P/E of 26.5, I do own the stock because I am trying to diversify.” Sheesh. Hope you are a little humorous with those two bad reasons to hold a stock. Seems a bit like getting a second (overweight) wife because the first good one won’t do.

  2. I’ve never understood how a company with 40% gross margins could be considered a discounter. All the good discount foods guys have gross margins in the teens (Costco, Aldi, etc.) and the discount clothing guys like TJX are in the 20s. Dollarama has increased their gross margins by ~10% since 2008 which has made the financial performance amazing, but I feel as though they’ve destroyed any moat they might have had.

    • You can get a pregnancy test at Dollarama for C$1.25. It’s several dollars elsewhere. They just go after the high-margin items like candy (although Dollarama discounts it less than its other items), clothing with no size, etc. etc. I bought an awesome pair of kitchen shears/scissors for $4… it’s titanium.

  3. Pingback: A model portfolio of large cap stocks – Glenn Chan's Random Notes on Investing

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