Don’t look now, but an extremely bullish technical indicator, the head and shoulders (H&S) bottom, is in the works for Dollarama (TSX:DOL) stock.
Should the reversal pattern come to full fruition, the stock could find itself at rocketing to $82, essentially making up for two years of lost time sparked by a slowdown of same-store sales comps.
Back in January 2018, when Dollarama stock was flirting with its all-time highs, I strongly urged investors to ditch the stock, as far too many headwinds would cause share to correct violently to a more reasonable valuation.
Indeed, that’s what happened as Dollarama stock proceeded to be cut nearly in half. That was largely a fundamental call, and although the promising technicals inspired me to revisit Dollarama, it’s always vital to consider the fundamentals if you are, in fact, a long-term investor and not a swing trader who’s mostly reliant on the technicals.
The painting that the technicals have painted is a thing of beauty, but as you may know, the technicals can breakdown, so it’s prudent to have a sound fundamental thesis, so you’re not left holding the bag in the event of a technical breakdown.
Given there have been meaningful changes going on behind the scenes since the stock’s downfall (and a reset valuation), the fundamental story has changed. However, many of the original headwinds I outlined in my initial bearish piece are still a cause for concern for the discount retailer.
Rising competition in the domestic market is still a top concern for the company, as foreign competitors look to take share in a Canadian discount retail market that’s mostly been dominated by Dollarama over the last decade.
Dollarama still provides a tough-to-match value proposition for consumers. As Canadian consumers tighten the belt, dollar store chains like Dollarama stand to benefit from the substitution effect as Canadians gravitate away from pricier options to get the most bang from their buck.
The only issue is that mounting competitive forces could make it difficult for Dollarama to sustainably grow its same-store sales while expanding upon its gross margins.
In my prior piece, I highlighted the fact that same-store sales trends were less meaningful if they come at the expense of margins, and urged investors to wait for the company to get both on the right trajectory before paying up for Dollarama’s expensive stock.
Fortunately, management recognized that it’s going to be tougher to generate an outsized economic profit in the domestic market moving forward, thereby inspiring them to pursue international growth outlets to satisfy the high growth expectations of investors.
While an international expansion bodes well for Dollarama’s long-term growth profile, investors must remain cautious, as the magnitude of success at home is no guarantee future success in a new market with distinct tastes.
While there are still many uncertainties (and headwinds), the stock is not as risky as it once was given its now more reasonable valuation and its international growth outlet in Latin American discount retailer, Dollarcity.
At the time of writing, shares of Dollarama trade at 19.5 times next year’s expected earnings and 3.9 times sales — not prohibitively expensive as far as growthy discount retailers are concerned.
While the year-ahead growth outlook could be better, I certainly wouldn’t rule out a scenario in which the stock could climb back to new highs should management be able to pull off the unthinkable and expand upon margins with stronger same-store sales growth in an upcoming quarter.
Expectations are somewhat muted going into Dollarama’s Q4 2020 results (to release in late-March), so it’s entirely possible that Dollarama could have a stage set for blast-off in the first half of 2020.
So, is $82 (~75% upside) possible in the first half possible? As far-fetched as it seems, I wouldn’t rule it out at this juncture.
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.