Dollarama (TSX:DOL) has been one of the best growth stocks the last decade. Now, however, as growth in the economy and in Dollarama’s business begin to slow, investors have taken some profits off the table. The stock came down almost 40% last year, and although it’s recovered some of those losses, it’s still sitting off its 52-week highs.
Dollarama is the largest dollar store operator in Canada. Currently, Dollarama owns and operates 1,225 stores across Canada. Items are sold for between $1 and $4 dollars. The industry itself and the goods it sells are quite competitive. It competes against dollar store peers, convenience stores, but also large big-box stores, depending on the products.
The dollar store industry is defensive though, which is a positive. Although Dollarama has done a fantastic job to grab and grow market share in the tough industry in the past. The pressure the stock faced last year was warranted due to some short-term problems, the worry over debt levels and the slowing of growth.
The same-store sales growth (SSSG) slowing down was inevitable due to the previous reliance on price increases. In more recent quarters, consumers have been upset over price increases, which has pressured management to keep prices flat. Management wants to protect and even improve its customer value proposition; as a result, there was an impact on gross margins. Additionally, minimum wage hikes also had a negative impact on margins.
Because of the lack of price increases, management has tried to make up the SSSG with larger basket sizes per customer, through new merchandising. This past quarter the SSSG of 2.6% was due to a 3% increase in basket size, which was offset by lower traffic. Historically, SSSG has been 4-5%, but in current market conditions management is guiding for 2.5-3.5%.
Nonetheless, there are additional opportunities for growth. Currently, the company is opening around 65 stores a year and will continue to do so for the foreseeable future. Management has set a target of 1,700 stores by 2027. Dollarama also just launched its online store in January. The store offers a selection of its most popular products for delivery by the case.
Another big opportunity investors are excited about is the option to buy Dollar City in 2020. Dollar City is a dollar store company founded in 2009 operating in Latin America. It has 169 stores total with 74 in Colombia, 43 in El Salvador, and 52 in Guatemala. Dollarama has provided consulting and sourcing services and has the purchase option to buy 50.1% beginning in 2020.
Financially, Dollarama does a tremendous job generating returns on invested capital through its large-scale operation. The vast growth in revenue and income for so long has allowed the company to raise the dividend each year. Management has also been aggressively buying back shares.
Share buybacks are most likely going to stop soon as the rising debt load needs to be attended to. The net debt for Dollarama has been growing rapidly the past couple of years, and management has acknowledged it needs to be slowed down.
At the current price, there could be lots of upside if Dollarama can continue its mighty performance, but if growth continues to slow, it could actually be overvalued.
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Fool contributor Daniel Da Costa has no position in any of the stocks mentioned.