Dollarama rose just 4.5 per cent this week, but the stock is up more than 30 per cent over the past 12 months.Fred Lum/The Globe and Mail
Investors are having a tough time trying to figure out what to do with retailing stocks right now, given soaring inflation and signs of an oncoming recession. But if this week’s activity is any indication, low expectations can lead to big returns.
That’s particularly true among humble dollar stores, which may be turning the tumultuous backdrop to their advantage.
Dollar General Corp. jumped 13.7 per cent on Thursday after the company raised its full-year outlook. Dollar Tree Inc. surged 21.9 per cent after it reported an increase in its first-quarter sales.
Canada’s Dollarama Inc. DOL-T rose just 4.5 per cent this week, but the stock is up more than 30 per cent over the past 12 months.
If this strong performance is making your head spin, that’s because it follows recent despair over the health of profits at leading retailers.
Walmart Inc. set markets on edge earlier in May when it reported that inflation was cutting deep into its earnings.
Target delivered even worse results just a week ago. The shares sank 25 per cent on May 18 and dragged down other retailers.
The takeaway from this carnage: Retailers are entering a world of pain as they face the double-whammy of cash-strapped shoppers and rising costs.
Hold on, though: Dollar stores are suggesting that they can get through this tumultuous period, and some observers expect they can even expand their market share.
“Dollarama’s compelling value proposition continues to resonate well with consumers,” Patricia Baker, an analyst at Bank of Nova Scotia, said in a report this week.
She added: “The high inflation backdrop could also favour Dollarama as consumers shift to value.”
The idea here is that dollar stores can offer respite from high-priced items during uncertain times when borrowing costs are rising and inflation is pricing out some consumers from mainstream retailers.
What’s more, dollar stores can introduce a greater selection – including more things costing well over a dollar – to entice consumers during these inflationary periods.
In the fourth quarter of its fiscal year, ended Jan. 30, Dollarama said that 75.5 per cent of sales originated from products priced higher than $1.25. That compared with 73.8 per cent in the fourth quarter of the previous year.
Now, analysts are more focused on the priciest items as Dollarama confronts inflation.
Chris Li, an analyst at Desjardins, recently looked at products at the retailer priced between $3.50 and $4, and made comparisons with equivalent products at Walmart and Amazon.com. The result: Products at Dollarama were about half the price.
That allows the retailer to roll out products costing up to $5 this summer, he expects.
“We believe the large price gap should provide Dollarama with the flexibility for mark-ups while still maintaining its compelling value proposition,” Mr. Li said in a note last week.
Trevor Chang, an analyst at Odlum Brown, said that Dollarama holds another advantage over traditional retailers: It is less exposed to consumers retrenching from buying bigger-ticket items.
“During the pandemic, people were moving. Consequently, they bought a lot of furniture, new kitchenware and stuff like that. Those sales are really slowing down,” Mr. Chang said in an interview.
Investors are catching on.
While Target’s share price is down 29 per cent this year, dollar stores are enjoying impressive rebounds as the bullish argument kicks in. After this week’s gains, Dollar General’s share price has pared its decline to just 3 per cent this year. Dollarama is up about 11 per cent over the same period.
Whether the stocks are still a good bet depends to some extent on if dollar stores can indeed raise prices and expand their product lines without triggering a backlash among consumers used to seeing items priced near a dollar.
“It may lead them to start to think of other options like Walmart or Amazon. It blurs the category as those prices rise,” David Ian Gray, principal at DIG360, the Vancouver-based national retail consultancy, said in an interview.
Still, a number of analysts are upbeat about Dollarama.
Ms. Baker expects that the company can increase its quarterly profit, on a per share basis, by 20 per cent when it reports its financial results on June 8.
Mr. Chang expects that stronger sales in seasonal and party products, as pandemic restrictions recede, can offset any weakness in general merchandise.
“The story is still very attractive here,” he said.
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