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Dollarama Inc. (TSX:DOL) Finally Falls off a Cliff: Buy the Dip or Jump Ship?

What an absolute bloodbath it’s been for Dollarama (TSX:DOL) over the past week!

All year I’ve been warning investors to throw in the towel on their shares of Dollarama (TSX:DOL) as both the sky-high valuation and increased competition within the Canadian discount retail scene were going to become detrimental long-term headwinds that’d leave a dent in the company’s top and bottom-line and result in a nasty correction to more reasonable levels.

Moreover, I expressed my distaste in management’s decision to repurchase their own shares at “absurd” multiples, questioned the company’s lack of innovative concepts, and disapproved of the unattractive-looking, “cluttered” store layouts that’d hurt the firm’s same-store sales growth (SSSG) numbers.

Unfortunately, many investors probably hung onto their shares, as it made them a heck of a lot of money over the course of many years. It’s hard to ditch your long-time winners, after all!

In past years, Dollarama enjoyed a dominant position in discount retail thanks to the firm’s ability to offer unmatchable value to its consumers. Unfortunately, the competition is starting to catch on, and they’re licking their chops to get in on this relatively untouched market that’s ripe for disruption.

Dollarama’s non-existent moat and millennial-unfriendly décor have left the company extremely vulnerable to new entrants like Miniso who are also competitive when it comes to value, but unlike Dollarama, they’ve got innovative, exclusive items and the in-store décor makes for vastly superior customer experiences.

Management needs to get on top of the in-store experience and exclusive offerings to become great again. Dollarama should be spending money toward such initiatives, not using it to buy back shares at what I believe are peak levels in the company.

If Dollarama’s management team can’t proactively respond to the millennial revolution, I expect shares to get slammed further and would continue to recommend Dollarama as a compelling short-sell.

Still expensive after entering bear market territory

At the time of writing, Dollarama shares have shed 20% in the two trading sessions following the firm’s quarterly earnings report. The stock is over 25% off from all-time highs, bringing investors into bear market territory, an unfamiliar terrain for long-time shareholders.

Although shares may appear cheaper after the dip, I’d still argue that given the countless number of headwinds, the stock is still expensive and has much further to fall. The stock trades at a 26.84 trailing P/E, a 4.2 TTM P/S, and a 23.5 TTM P/CF.

This is still a valuation that’s indicative of a growth name that’s firing on all cylinders. Given the drastic SSSG slowdown and the potential for further disruption, I’d recommend investors avoid buying the dip until the dust settles at the low $30 levels.

Foolish takeaway

It’s been an excellent run for Dollarama, but the industry is about to get crowded.

Management is going to need to spend more to drive more traffic into its stores, especially as competitors like Miniso roll out new locations across the country.

The easy days are long gone, so I suspect gross margins will be further pressured or ample investments will need to be remade to reinvent the in-store experience. That’s money that wouldn’t need to have been spent five years ago. As such, Dollarama looks slated to suffer from the law of diminishing marginal returns.

Dollarama is still a great business; it’s just not priced well, and return expectations are going to need to be reset for the new retail environment that’s up ahead.

Stay hungry. Stay Foolish.

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 Joey Frenette has no position in any of the stocks mentioned.

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