Dollarama (TSX:DOL): Is the Discount Retailer’s Stock Discounted?

Dollarama Inc. (TSX:DOL) has its fair share of baggage, but is it enough to stop you from buying the dip?

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Dollarama (TSX:DOL) stock plunged nearly 10% from peak to trough following the release of its third-quarter fiscal 2020 results, which missed on earnings.

Shares of the Canadian discount retailer are now down 15% from its all-time highs, but before you buy the dip, you may want to dig deeper into the details to see whether the stock is discounted like the products it sells.

A weak third quarter with some soft spots

Dollarama missed on EPS by $0.02, but on a positive note, same-store sales growth (SSSG) comps were robust once again at 5.3% (up from 3.1% over the same period last year.)

Management now sees SSSG numbers being at the high end of their original range, but before you get excited, investors ought to know that the uptrending SSSG numbers come at a cost.

In a prior piece, I highlighted the fact that SSSG trends meant less if it came at the expense of margins.

“Strong SSSG trends would likely continue to be at the expense of margins and would urge investors to look for margins to trend upwards in conjunction with SSSG numbers before paying up for a name that I still think is at risk of another substantial correction.” I said in a prior piece, as I urged investors to sell the stock before its December 5th earnings.

For long-time Foolish followers, you may remember that I called Dollarama’s original crash back in January 2018 before the stock fell into a tailspin.

I highlighted rising competition, limited expansion potential, overvaluation, and poorly timed share buybacks as just some of the reasons why I was so bearish on a name that had made many investors very rich.

Fast-forward to today and many of my initial concerns are still very much in play.

Dollarama may have acquired its way to a meaningful growth outlet outside of Canada (its stake in Dollar City), and the stock is definitely cheaper than it was back in January 2018.

However, competitive pressures are still weighing, and I don’t think Dollarama will be able to drive substantial SSSG alongside significant margin expansion sustainably.

For Q3/20, SSSG was given a boost thanks well-prepared Halloween season, but once again, gross margins left a lot to be desired.

Price inflation is making it tough for margin expansion and looming competition will make it even tougher. As such, I’m not biting on the SSSG trends until gross margins, which pulled back 60 basis points year over year, can get back on the right track.

At the time of writing, Dollarama stock trades at 19 times next year’s expected earnings and 3.8 times sales, which isn’t a high price to pay for low double-digit growth.

I wouldn’t back up the truck after the latest quarter, though, as margin pressures may spark a management guidance downgrade after the fact, which could cause the stock to be back in the $30 range.

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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