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Dollar Tree has a steep curve relative to peers
admin | January 17, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The Dollar Tree (DLTR) debt curve is steep relative to peers, offering an attractive opportunity for IG investors to pick up additional yield. The 4.2% 5/15/28 bonds look particularly attractive on a g-spread basis, trading roughly 41 bp wide to the 4.0% 5/15/25 bonds – a curve that was only 15 bp at issue. Since then DLTR has reduced debt, improved its leverage metric by over a turn, and repaid all senior secured debt. Dollar General’s (DG – Baa2/BBB) 2025-2028 curve, DLTR’s closest peer, is currently only worth 17 bp.
Exhibit 1: BBB retail 1-year to 10-year curve (department stores excluded)
Source: Bloomberg
Solid debt reduction and fully unsecured capital structure
Since DLTR closed on its acquisition of Family Dollar on 11/2/15, management has repaid over $4 billion of debt and brought lease adjusted leverage down from a high of 5.0x to 2.6x currently. The debt and leverage reduction led to upgrades by both Moody’s and S&P to investment grade in 2018. Both rating agencies highlighted management’s conservative financial policy as they do not pay a dividend and only began repurchasing shares at the start of 2019 ($200 million of share repurchases year-to-date). Post upgrade, the company continued on its debt reduction path while paying down all of its secured debt. As such, Moody’s recently assigned a positive outlook to DLTR’s Baa3 rating, highlighting both the continued debt prepayments and strong operating performance. Leverage is expected to continue to improve as the Family Dollar turnaround gains momentum.
Exhibit 2: DLTR lease adjusted debt and leverage (FY15 – LTM19)
Source: Company reports, Amherst Pierpont Securities
DLTR initiated a store optimization program in 2019 known has H2 for the Family Dollar banner, with a remodel target of roughly 1,000 stores for the year. The new H2 model has better shopping adjacencies, more productive end-caps and a greater number of freezers and coolers to provide for a greater offering of consumables. Furthermore, the model has improved merchandise offerings by including Dollar Tree $1.00 merchandise throughout the store. Management planned for the closing of 390 underperforming stores and the re-bannering of roughly 200 Family Dollar stores to Dollar Tree. The store optimization initiatives have largely been successful as management noted it is driving increased loyalty, repeat visits and improved value perception. As such, management noted that Family Dollar H2 “control” stores were witnessing greater than 10% same-store sales (SSS) growth. This improved overall SSS at the Family Dollar banner which has now posted four consecutive quarters of SSS growth, and an average SSS growth of 2.0% on a last twelve month’s (LTM) basis (Exhibit 3). Additionally, Family Dollar has been witnessing solid performance in its consumables business having posted its 12th consecutive quarter of positive SSS. Management noted that with the format being so successful, they plan to renovate another 1,000 Family Dollar stores to the H2 format in 2020.
Exhibit 3: DLTR same-store sales by banner
Source: Company reports, Amherst Pierpont Securities
Starboard exits stake
Early in 2019, Starboard announced a 1.7% stake in DLTR and suggested the company look to sell the Family Dollar banner in an effort to unlock value. The activist investor also urged the company to change its merchandise mix at Dollar Tree to include higher priced items, similar to peers, and sought to gain control of DLTR’s board with its nomination of seven directors. While DLTR noted that they would evaluate Starboard’s suggestions, they did highlight that the director nominations were made without engaging with management.
In an effort to put further pressure on DLTR, Starboard increased its stake by 1.1% in February 2019. Yet by April, Starboard withdrew its nomination of board candidates as they were pleased with the improved performance at Family Dollar coupled with management’s intention to perform a test of multiple price points at its Dollar Tree banner. As the year progressed, Starboard reduced its stake twice before fully exiting its position in November 2019.
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