Dollarama (TSX:DOL) stock is beloved by Canadian bargain hunters, not so much because of its valuation, but because of its business model. The stock isn’t cheap going by conventional metrics, trading at 30 times earnings. But it is a bargain stock in one sense:
It offers great bargains to its customers at its chain of 1,400 stores nationwide.
This is a significant advantage in today’s economy. Ever since the start of 2022, inflation has been elevated, leading many shoppers to seek out lower-priced versions of the products they buy every day. Dollarama is one store that caters to their needs. Many common grocery items, such as bread, cola and Kraft Dinner, are cheaper at Dollarama than anywhere else. It’s certainly a “bargain stock” in that sense. The question is, is DOL’s cost advantage enough to overcome the rather rich valuation that the company has reached in the markets?
Dollarama stock: valuation
Although Dollarama is a “bargain stock” going by sector (discount retail), it is no bargain in terms of valuation. At least, not on the surface of things. At today’s prices, it trades at:
- 30 times earnings.
- 4.8 times sales.
- 114 times book value.
- 24 times operating cash flow.
It’s certainly not a cheap valuation if you take it at face value. However, Dollarama has one factor going for it that makes the valuation not quite as steep as it appears:
Growth.
Because of its low price offerings in a high inflation period, Dollarama has been growing rapidly. In the last 12 months, the company has grown its revenue at 18.5% and earnings at 26%. These are very fast growth rates. In a period in which big tech is barely growing at all, Dollarama is growing at double digits. As a result, its PEG ratio (the P/E ratio divided by the earnings growth rate) is only 1.2. That implies that the stock may be cheaper than it appears right now – certainly it’s cheaper than it looks if last year’s growth continues next year.
A recession-resistant business model
By far the biggest thing that Dollarama has going for it right now is a business model that is resistant to various adverse economic circumstances.
First, like most discount retailers, it is recession resistant. When recessions hit, people tend to suffer unemployment, which leads them to search for lower priced alternatives to goods they already buy. Dollar stores like Dollarama naturally see an increase in sales during recessions for this reason. During the COVID-19 recession, Dollarama actually managed to grow its sales, when most Canadian companies saw their revenues decline in the same period. It was a tough period for the economy, but Dollarama did well, as Canadians flocked to its stores for their low priced goods.
Second, Dollarama is also perfectly set up for periods of high inflation, like the one we’re in now. Rising prices have much the same effect that recessions do: they make people more price sensitive. As a result, many shoppers flock to dollar stores when prices rise dramatically. That happened in the last year, leading to a double digit surge in revenue for Dollarama.
