Is Dollarama Inc Canada’s Best Retailer?

In a tough retailing market, Dollarama Inc (TSX:DOL) is one of Canada’s best performers. Does it deserve a spot in your portfolio?

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It’s a tough time to be a Canadian retailer.

Canadian consumers are wallowing in a huge amount of debt. Housing prices across the country are at record highs, and even with low interest rates, Canadians are struggling to keep up. Many Canadians have used lines of credit to borrow against their rapidly inflating property values, which seems like it’s a bullish sign on the surface, but in reality is just kicking the can down the road. At some point, all the debt taken on will cause problems. This obviously isn’t good for the retail sector.

There are also many U.S. retailers expanding into Canada. Target Corporation (NYSE: TGT) made the biggest splash in 2013 when it opened more than 100 stores in old Zellers locations. Other successful retailers from down south have also dipped their toes into the water, including Nordstrom Inc. (NYSE: JWN), Marshalls, and Saks, which was recently acquired by Canadian retailer Hudson’s Bay Co (TSX: HBC).

These two factors, plus lackluster overall growth, are weighing down retailer shares. Several have delivered dismal results and have sunk to multi-year lows. Even the successful ones are struggling a bit.

Well, except for Dollarama Inc (TSX: DOL), Canada’s largest chain of dollar stores. Same-store sales are up, the chain is expanding, and shares of the company have performed admirably since its IPO in late 2009, rising more than 300%. Is this just the beginning of the company’s domination? Or has the company peaked?

I think it’s the former. Here’s why.

Since opening in 1992 as a single location in a Quebec strip mall, Dollarama has been enormously successful. The chain currently has more than 800 locations, with plans to add at least 80 more. Critics who think the concept is overdone are countered by an analyst report released earlier in the year that predicted Canada could easily support an additional 1,700 dollar stores over the medium to long term. Based on that, it would seem we’re only in about the fourth inning of Dollarama’s growth story.

The numbers continue to be great. Over the most recent quarter, overall sales were up nearly 12%, while same-store sales growth came in at 3.3%. Operating margins continued to expand, and overall earnings rose 25%. Considering the difficult Canadian retail market, you really can’t beat those results.

Additionally, the company is currently in a test project in Central America. It struck a deal with Dollar City, a 15-store chain in El Salvador, to supply it with merchandise. The deal also comes with an option to buy the whole chain outright in 2019. Results out of Central America have been positive thus far, and if successful, Dollar City could prove to be the company’s new growth story once operations in Canada mature.

The company’s valuation is expensive, but that’s to be expected of a firm growing so quickly. Its shares trade at 25 times trailing earnings, and 21 times forward earnings. It also trades at nearly three times sales, much more than nearly all its rivals. However, although shareholders have been treated to annual dividend increases since the company became public, Dollarama isn’t much of a dividend story. Shares currently yield just 0.7%, and there’s little indication that’ll go up soon. Too much money is being funneled into store expansion.

Dollarama is still growing strongly after 800 stores. The company has terrific results, and could even benefit from an economic slowdown, since consumers will seek cheaper merchandise. Sure, it’s expensive, but growth-oriented investors can attest to paying more for quality growth names. That’s exactly what Dollarama is, and why it should be in your portfolio.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith has no position in any stocks mentioned.

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