In the retail world, Dollarama Inc. (TSX:DOL) has been one of the decade’s best success stories. It successfully addressed the value shopper, driving growth and profits, which have accelerated rapidly. Not surprisingly, Dollarama stock has been a star performer and everyone loves it.
But has the valuation gotten ahead of itself?
Dollarama stock’s out-of-this-world performance
Looking at a five-year graph of Dollarama’s stock price, one cannot help but to notice its steady and strong upward climb.
Yet, retail stocks are cyclical stocks. There’s really no escaping this. Although Dollarama has recently seemed to escape this fact, I think it will show its ugly head sooner or later. So, let’s look at Dollarama’s business and explore what has been going on.
There are a couple of reasons why Dollarama has escaped the hit in spending that most other retailers are experiencing. Firstly, Dollarama sells a wide variety of products at price points of anywhere between $1 or less and $5. Clearly, there’s a value proposition here, with Dollarama offering the best bang for your buck. Secondly, a large portion of what Dollarama sells are consumables. These are day-to-day living products that get used up pretty quickly and have to continuously be replaced, such as tissues and food.
Consumer spending under pressure
Rising interest rates and inflation have put pressure on consumers’ wallets. This means they’re cutting spending. As discussed, Dollarama is more immune to this than other retailers, but it is not 100% immune. And this is something I think we should dig into a little deeper.
Back when Dollarama reported its last quarterly result, the company signaled that sales growth is expected to slow as the year progressed. In fact, it was already slowing as of September, when same-store-sales growth was running at 11%. Dollarama had entered the quarter with same-store-sales growth of 15%.
On this note, management continues to be conservative with its revenue growth guidance, as they themselves continue to be weary of the macro-economic environment. At their last update, the guidance given implied 4% to 6% same-store-sales growth in the back half of this year. Still good, but much lower than previous quarters.
Valuation remains lofty and priced for perfection
Dollarama stock has long been an investor favourite – and for good reason. In the last five years, revenue has grown 42% to $5 billion in its fiscal 2023 ended January 2023. And since then, revenue growth has remained strong, with same-store-sales growth of 17% in Q1 and 15.5% in Q2.
On the other hand, the stock continues to have a very lofty valuation, one that has all the best expectations baked into it. This is not necessarily a bad thing, but Dollarama stock trades at almost 30 times this year’s expected EPS, which is expected to grow 22.5%.
This is the type of valuation that makes a stock react especially negatively to anything that comes in below expectations and weakening trends. As discussed, I think that revenue growth will likely be hit this year, and this would not bode well for Dollarama’s stock price. Its next quarterly report will be released December 13, so stay tuned for an update.
The bottom line
Nobody can deny that Dollarama has been one of Canada’s greatest retailers. As the company continues to expand and revenue growth likely declines, I think the risk of seeing a stock price correction is high. I’ve learned to be very wary of overvalued stocks that everybody “loves” – that’s when valuation gets out of hand.
