Inflation and rate hikes are still the themes driving the markets this year. Although some ease is expected, growth stocks might still trade volatile given the uncertainties. So, where can one invest in the current environment?
One name that looks strong in the current inflationary environment and offers decent growth prospects is Dollarama (TSX:DOL). It is a leading discount retailer in Canada with a proven track record and a low-volatility stock.
Why Dollarama?
Dollarama will likely beat these current macroeconomic challenges because of its strong fundamentals and stellar execution. While many companies saw revenues and margins drop since last year, Dollarama has played well and rather seen higher revenue growth and margin expansion.
As a result, DOL stock returned 25% last year when the TSX Composite Index fell 5%. It has outperformed markets in the short term and the long term as well. DOL stock has returned 700% in the last decade, more than 10 times higher than the index.
Dollarama operates 1,486 stores in Canada — many more stores than its peers. Such a large presence offers convenience and allows premium pricing in some cases. Last year, it introduced an additional price point of $5 to increase the average order value. This has worked well in tackling inflation and has been reflected in revenue growth.
Dollarama sources its merchandise from low-cost suppliers, mainly from China and Mexico. It does not get into long-term contracts with suppliers and rather prefers to source on an order-by-order basis to retain flexibility. It also customizes packaging that enables higher bargaining power and allows superior margins.
In the last 10 years, its revenues and net income have grown by 10% and 13%, compounded annually. Note that Dollarama’s store count and financial growth have shown a strong positive correlation over the years. Its operating margins in the same period averaged over 20%, which is quite admirable in the retail industry.
Many peers, including south-of-the-border dollar-store operators, saw much lower and unstable margins in the same period. Apart from the differentiated execution mentioned above, it is also the product mix that drives the variance. For example, Dollarama serves food and other consumables as well, which is rare among peers.
Dollarama’s return on capital came in at 33% in the last five years. It indicates strong profitability and much more efficient use of capital.
What’s next for Dollarama?
Dollarama aims to reach a 2,000-store count by 2031. DollarCity, it’s subsidiary in Latin America, is expected to be a key growth driver for Dollarama in the next few years. It plans to reach a store count of 850 by 2029. Dollarama intends to replicate its proven strategy with DollarCity in many densely populated areas. So, this will likely accelerate its top-line growth and lead to further margin expansion.
Dollarama deploys its excess capital to buy back its shares and dividends. Though it offers an insignificant yield, it has increased dividends consistently since 2011. This indicates its stable, sound balance sheet position and visible earnings growth for the future.
Conclusion
After a brief hiatus, DOL stock has again moved higher, gaining around 8% since last month. It is currently trading at 30 times 2023 earnings and looks a tad overvalued. However, considering its margin stability and dominating market position, the premium is warranted. It will likely continue to drive stable shareholder returns driven by financial growth.
