Dollar Tree, Inc. (NASDAQ:DLTR) Investment Memo 12/18/15 · 12/24/2015 · Dollar Tree, Inc. (NASDAQ:DLTR) – Investment Memo – 12/18/15 Recommendation: Long Dollar Tree (NASDAQ:DLTR)

Dollar Tree, Inc. (NASDAQ:DLTR) – Investment Memo – 12/18/15

Recommendation: Long Dollar Tree (NASDAQ:DLTR) equity

Current Stock Price: $76.09

Target Stock Price: $130.00 (71% upside)

Timing: 2-3 years

Catalyst: successful integration of Family Dollar acquisition

Summary Thesis

Dollar Tree (DLTR) operates over 14,000 dollar stores and discount grocery stores in the

US and Canada under the Dollar Tree and Family Dollar (FDO) banners

In July 2015, Dollar Tree completed the $9.5bn acquisition of Family Dollar. The

acquisition doubled the company’s sales, added over $7.6bn in debt to the balance sheet,

and diversified the company into the (multi-price) discount grocery business as compared

to its legacy business of dollar stores selling goods at a fixed price of $1

The acquisition of Family Dollar presents an extremely attractive opportunity for DLTR

shareholders to invest alongside a proven management team and board as they create

value from a levered transaction with significant synergy and earnings improvement

potential

Wall Street has viewed the Family Dollar transaction with some skepticism due to the

departure from Dollar Tree’s core dollar store business and the leverage taken on to

finance the deal. The market also questions whether the announced synergies can be

realized and is not confident the Family Dollar business can be turned around

o Family Dollar is not so different from Dollar Tree – both are discount

convenience stores and have significant overlap in inventory sold

o The synergy expectations are very conservative based on management’s

commentary and when compared to synergies from other retail deals

o Family Dollar has suffered from glaring strategic mistakes and under-investment.

DLTR’s best-in-class management team has outlined a logical plan and should be

able to improve Family Dollar’s profitability

o Current leverage is not overbearing and if the FDO integration is successful, the

leverage taken on to finance the deal will enhance shareholder returns

Dollar Tree shares are attractively priced and trade at a slight discount to peers despite

significantly higher earnings growth potential

With a target stock price of $130 by 2018, I believe an investment in Dollar Tree can

result in an IRR of 20% over the next 2-3 years as the company integrates the Family

Dollar acquisition and continues to execute on the profitable growth of Dollar Tree stores

Capitalization Pro-forma Financials Valuation

Market Cap $17,866 2015 Sales $20,099 EV / 2015 EBITDA 11.8x

Cash $1,111 2016 Growth 6.0% EV / 2016 EBITDA 9.5x

Debt $9,344 2015 EBITDA $2,129 EV / 2016 Sales 1.2x

Enterprise Value $26,098 2015 Margin 10.6% Price / 2016 EPS 16.6x

$ in millions. Data as of 12/18/2015 (Q3 2015). Financial projected based on pro-forma base case model.

2

Company Overview

Dollar Tree operates under the Dollar Tree and Family Dollar retail store banners

o The company closed on the acquisition of Family Dollar in July 2015

o The two franchises are very complementary of each other and each represent

roughly half of combined sales

The Dollar Tree business

o Dollar Tree aims to provide the best value to customers at the $1 price point

o Most items are sold at the same price/unit that can be found at every-day-low-

price stores like Walmart, but package sizes are scaled down

For example, in 2015 Dollar Tree sold $1 packages of prime rib which

contained 6 ounces of meat sold at the same price/unit as Walmart’s

private label brand

o The company will sell anything that can meet its strict requirements for margin

and return on investment. Scale is critical to making the $1 price point work

o Dollar Tree works directly with manufacturers to source inventory which is a mix

of branded and private label products. The company will buy in bulk to lock-in

low priced goods

DLTR will also buy aged promotional inventory from other channels at a

discount; for example, candy branded for movies no longer in theaters

o The company’s small-format stores are located in suburban strip malls and other

off-mall locations which are convenient for customers and have low cost rent

o DLTR leases almost all of its stores and owns its distribution facilities

The Family Dollar business

o Family Dollar is a convenience-oriented grocer and variety store that targets the

middle to lower-income consumer who is trying to save on essential purchases

Dollar Tree Family Dollar

Store Count ~5,500 ~8,000

Pricing Strategy Everything is $1 Multi-price

Merchandise Consumables (50%),

Discretionary (46%),

Seasonal (4%)

Consumables (72%),

Home Products (10%),

Seasonal / Gadgets (10%),

Apparel (8%)

Real Estate Strategy Mostly suburban Mostly urban and rural

Store Size 8,000 – 10,000 sq. ft. 7,500 – 9,500 sq. ft.

Target Customer

Demographic

Broad range of middle

America

Low to lower-middle income

Tag-line Thrill of the “hunt” Your neighborhood discount

store

Sales / Store $1.69 million $1.33 million

Sales / Sq. Ft. $192 $180

Est. 4-Wall EBITDA $0.27 million (16.1%) $0.11 million (8.3%)

Source: company filings and modeling estimates.

3

o FDO sells at multiple price points (unlike Dollar Tree) and transitioned to an

every-day-low-price model in 2014 after a promotion driven model used between

2011 - 2014 failed

o Family Dollar’s stores are located in mostly urban inner-city neighborhoods and

rural areas. It operates small format stores that are more convenient for customers

than large box retailers like Walmart and Target

o The typical Family Dollar customer makes frequent trips and purchases in small

quantities. A large segment of customers use FDO as their primary grocer (often

due to a lack of traditional grocery stores in urban and rural neighborhoods)

o FDO leases almost all of its stores and owns its distribution facilities

Legacy Dollar Tree is a Best-in-Class Operator

Over the past 10 years, legacy Dollar Tree has consistently grown sales and improved

profitability

o Since 2004, Dollar Tree’s sales have grown every year. Growth has been almost

entirely organic and has resulted from both opening new stores and from same

store sales growth

o Dollar Tree’s disciplined focus on expenses has enabled it to compound EBITDA

and EPS growth at higher rates than sales growth, creating significant value

o Finally, DLTR has continuously improved the operating metrics of its business

31 consecutive quarters of SSS growth since Q1 2008

Inventory turns improved from 3.5x in 2004 to 4.9x in 2014

Return on invested capital improved from 14.8% in 2004 to 39.1% in 2014

In terms of operating metrics, DLTR has performed well vs. peers over the business cycle

Legacy Dollar Tree Financials

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 5Yr CAGR 10Yr CAGR

Sales $3,126 $3,394 $3,969 $4,243 $4,645 $5,231 $5,882 $6,631 $7,395 $7,840 $8,602 10.5% 10.7%

% Growth 8.6% 17.0% 6.9% 9.5% 12.6% 12.4% 12.7% 11.5% 6.0% 9.7%

Gross Profit 1,113 1,172 1,357 1,461 1,592 1,857 2,140 2,378 2,653 2,790 3,034 10.3% 10.6%

% Margin 35.6% 34.5% 34.2% 34.4% 34.3% 35.5% 36.4% 35.9% 35.9% 35.6% 35.3%

EBITDA 423 425 470 490 528 671 816 946 1,095 1,161 1,275 13.7% 11.7%

% Margin 13.5% 12.5% 11.8% 11.5% 11.4% 12.8% 13.9% 14.3% 14.8% 14.8% 14.8%

Diluted EPS 0.53 0.53 0.61 0.69 0.82 1.18 1.59 2.01 2.49 2.72 2.98 20.5% 18.9%

% Growth 0.1% 15.3% 13.7% 19.3% 42.5% 35.2% 26.5% 23.7% 9.6% 9.6%

Store Count 2,735 2,914 3,219 3,411 3,591 3,806 4,101 4,351 4,671 4,992 5,367 7.1% 7.0%

% Growth 6.5% 10.5% 6.0% 5.3% 6.0% 7.8% 6.1% 7.4% 6.9% 7.5%

Source: company filings.

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o Dollar Tree is more profitable and earns a higher return on capital than its peers

o DLTR has achieved a similar level of inventory turns and same-store-sales growth

as DG while more quickly growing its store base

o Family Dollar’s metrics have deteriorated since 2013 and have continued to

deteriorate in 2015

Dollar Tree has delivered shareholder returns well above peers and the market

Dollar Tree’s current management team has been at the helm over the past decade and

should continue to execute for shareholders

o Bob Sasser has been CEO since 2004; he is 63 years old

o Kevin Wampler has been CFO since 2008; he is 52 years old

o Gary Philbin has been COO since 2007; he is 58 years old

o The management team and board own a significant amount of shares, aligning

their interest with shareholders

Comparison of Dollar Store Operating Metrics Over the Business Cycle

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Dollar Tree

Store Growth 8.8% 6.5% 10.5% 6.0% 5.3% 6.0% 7.8% 6.1% 7.4% 6.9% 7.5%

SSS Growth 0.5% (0.8%) 4.6% 2.7% 4.1% 7.2% 6.3% 6.0% 3.4% 2.4% 4.3%

EBITDAR Margin 20.0% 19.2% 18.5% 18.5% 18.3% 19.6% 20.4% 20.7% 21.0% 21.2% 21.1%

Sales / Sq. Ft. $168 $156 $161 $155 $158 $167 $174 $182 $190 $187 $192

Inventory Turns 3.5x 3.7x 4.4x 4.5x 4.6x 5.0x 4.6x 4.6x 4.7x 4.5x 4.9x

ROIC 14.8% 15.1% 16.4% 16.6% 19.0% 28.2% 31.7% 34.7% 35.7% 34.3% 39.1%

Dollar General

Store Growth 7.4% 8.3% 3.8% (0.4%) 2.1% 5.6% 6.2% 6.0% 5.7% 6.0% 5.9%

SSS Growth 3.2% 2.2% 3.3% 1.9% 9.0% 9.5% 4.9% 6.0% 4.7% 3.3% 2.8%

EBITDAR Margin 12.9% 13.5% 8.6% 10.1% 12.4% 13.9% 15.5% 15.7% 16.1% 15.8% 15.4%

Sales / Sq. Ft. $160 $160 $163 $165 $180 $195 $201 $213 $216 $220 $223


ROIC 19.4% 20.7% 7.7% 3.5% 6.1% 9.4% 12.0% 13.3% 13.8% 14.2% 14.2%

Family Dollar

Store Growth 8.7% 7.9% 4.7% 4.2% 2.2% 1.3% 2.0% 3.5% 6.0% 6.4% 1.6%

SSS Growth 1.9% 2.3% 3.7% 0.9% 1.2% 4.0% 4.8% 5.5% 4.7% 3.0% (2.1%)

EBITDAR Margin 14.2% 12.7% 12.6% 12.8% 12.8% 13.6% 14.7% 14.5% 14.8% 14.3% 13.5%

Sales / Sq. Ft. $139 $141 $147 $151 $151 $158 $165 $174 $181 $189 $180


ROIC 20.2% 15.1% 16.8% 19.7% 18.4% 21.1% 27.6% 23.7% 19.0% 17.2% 12.4%

Source: company filings.

Shareholder Total Returns

1 Year 3 Year 5 Year

DLTR 12.7% 100.2% 170.4%

DG 1.9% 63.3% 133.2%

BIG 0.7% 45.3% 37.1%

FRED 2.2% 30.0% 25.4%

S&P 500 2.7% 44.6% 64.4%

Dividend adjusted equity returns as of 12/15/2015.

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Management and board own combined shares worth ~$630mm, excluding

stock options and unvested RSUs worth an additional $70mm

The Family Dollar Acquisition has the Potential to Create Tremendous Value

Dollar Tree announced the acquisition of Family Dollar on July 27, 2014 for $9.5 billion

in cash and stock

o DLTR issued $7.7bn in debt and issued 28.5 million shares (share count increased

by 13.8%). Net leverage increased from (0.1x) to 3.4x

o The transition didn’t close until July 6, 2015 due to a prolonged bidding war with

Dollar General and an anti-trust process

Value creation from the acquisition is expected to come from 3 buckets: leverage taken

on from the deal and the subsequent debt paydown, synergies achieved during the deal

integration and the turnaround of Family Dollar’s core business

Before the FDO acquisition, DLTR was under-levered. The levered capital structure will

boost shareholder returns as it has delivered growth and will transfer value to

shareholders as the debt is paid off

Before and After the Acquisition

Q4 2014 Q3 2015

Cash 864 1,111

Total Assets 3,493 16,699

Debt 683 8,344

Total Liabilities 1,708 12,557

Total Equity 1,785 4,142

EBITDA 1,275 2,129

Net Leverage (0.1x) 3.4x

Value Creation from FDO Acquisition

Leverage

Net Debt at Q3 2015 7,233

Net Debt at YE 2019 2,505

Debt Paydown 4,728

Synergies

Estimated Synergies by 2019 400

EBITDA Multiple 9.0x

Value of Synergies 3,600

FDO EBITDA Improvement

2015 EBITDA at 5% margin 691

2015 EBITDA at 9% margin 953

EBITDA Improvement 261

EBITDA Multiple 9.0x

Value of Margin Improvements 2,352

Estimated Value Creation Potential 10,680

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o Management has targeted total leverage of less than 3.5x EBITDA, which can be

achieved by 2016

o I expect the company to generate ~$850mm in free cash flow in 2016 and to have

EBIT interest coverage of ~5.5x

o The additional scale in the business provides Dollar Tree with more balance sheet

optionality once the debt is paid down to return capital or make other strategic

decisions

Management’s stated expectation of $300mm in synergies within 3 years is conservative

and could be revised higher

o $300mm in synergies represents 2.9% of Family Dollar’s sales. A study of 10

recent acquisitions in the retail industry found that the range of synergies was

between 5% - 7% of the target’s sales

o On the most recent conference call (Q3’15), management reiterated their

confidence in in being able to deliver “at least $300mm in annual run rate

synergies” by the end of the third year post-close and also mention that they

would be “disappointed if [they] don’t exceed this number”

o My base case assumes that $400mm in synergies or 4% of FDO’s sales can be

achieved by the 4th

year after the acquisition

Synergies are targeted to come from four buckets: sourcing & procurement, distribution

& logistics, format optimization, and SG&A

o The largest source of synergies is the cost of goods sold line which represents

$14.7bn of combined expenses

Right off the bat, management brought its purchasing teams together to

negotiate improved purchasing terms from its mutual suppliers

SKU standardization will also help. For example, Management noted that

the company had 5 SKUs just for Mayo

The company can more effectively use private label across its banners.

DLTR has ~40% private label sales, while FDO has 26%. Management

can increase the usage of higher margin private label at FDO and gain

better efficiencies by standardizing products

Precedent Retail M&A Transactions

Date Enterprise Target Financials Synr. EV / Synergies

Announced Target Acquiror Value Sales EBITDA EBITDA Announced Revised % Target Sales

10/27/2015 Rite Aid Walgreens 17,048 27,853 1,301 7.4x 1,000 3.6%

5/18/2015 Ann Taylor Ascena Retail Group 2,030 2,541 241 5.2x 150 235 9.2%

2/4/2015 Office Depot Staples 7,950 16,096 532 5.2x 1,000 6.2%

7/28/2014 Family Dollar Dollar Tree 9,185 10,378 815 8.2x 300 2.9%

5/15/2014 Dixons Carphone Warehouse 3,697 12,189 487 6.0x 134 1.1%

2/19/2014 Zales Signet Jewelers 1,200 1,879 77 6.8x 100 163 8.6%

11/26/2013 Jos A Banks Men's Warehouse 1,826 1,031 134 7.8x 100 9.7%

7/29/2013 Saks Hudson's Bay 2,726 3,187 266 7.5x 100 3.1%

2/20/2013 Office Max Office Depot 2,217 6,920 147 3.4x 500 7.2%

10/11/2011 99 Cents only Stores Ares 1,580 1,475 146 10.9x N/A

2/17/2010 Duane Reade Walgreens 1,166 1,809 71 6.0x 125 6.9%

8/12/2008 Longs Drug Stores CVS 2,599 5,431 280 9.3x N/A

3/12/2007 Dollar General KKR 7,005 9,170 739 9.5x N/A

Median 2,599 5,431 266 7.4x 6.6%

Average 4,633 7,689 403 7.2x 5.9%

Source: company filings, Capital IQ.

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The company can use COGS savings to make price investments and drive

better sales growth

o Distribution and logistics synergies are also large because the company operates

23 massive warehouse hubs

Warehouses are now serving both banners, which has increased overall

storage capacity, reduced shipping distances and allows the banners to

more efficiently expand. For example, DLTR has a large footprint in

California where FDO currently has a small footprint

The company can also negotiate better freight contracts

o Format optimization is the company making common sense investments in

existing stores to improve productivity, for example, expanding stores

The company is also converting the poorest performing FDO stores to

DLTR stores. The company sees hundreds of opportunities for these

conversions and had already converted ~200 units in the first 6 months of

integration. Because DLTR stores are a higher return concept, these

conversions are expected to increase overall profitability

Conversion of 200 FDO stores to DLTR stores can provide an

incremental ~$33mm in EBITDA

o SG&A and back office improvements will kick in on the back-end of the 3 year

integration timeline as the company upgrades its IT systems and better

understands where it can reduce headcount

A turnaround of the core Family Dollar business can provide additional upside and is not

baked into the synergy numbers

o Family Dollar transitioned from an every-day-low-price selling model to a

promotion driven model in 2011; however, FDO started to underperform in 2013

because customers found better value at its competitors and FDO decided to

switch back to EDLP in 2014. From 2012 to 2013, FDO also decided to accelerate

store count growth and expand SKUs by over 1,000 items

o Family Dollar put itself up for sale in 2014 after pressured by activist investors

and endured a year-long bidding war. During this period, FDO management was

distracted by the M&A process and under-invested in its stores

o The result of strategic missteps and the period of under-investment has led to

widespread deterioration in FDO’s margins and operating metrics which has

continued through the close of the acquisition

o Over the last 12 months, FDO has earned an EBIT margin of 4% vs. its historic

level of ~7% and Dollar General’s LTM EBIT margin of 9.6%

o Dollar Tree’s management believes it can bring Family Dollar back to an

operating margin in the 7% to 8% range over the next few years. Management

noted the turnaround in FDO was not baked into their synergy numbers and

should provide additional upside. Given management’s track record with Dollar

Tree, I think we can underwrite their ability to rehabilitate FDO

Wall Street hasn’t given full credit for the FDO turnaround with analysts

projecting future FDO EBIT margins in the 5% to 6.5% range, but not

near the 8% mark. This will be a likely source of future analyst upgrades

o Management’s plan to turnaround FDO is to make the shopping experience better

and provide more value to customers (through the initiatives mentioned above)

8

Dollar Tree immediately appointed company veteran and COO Gary

Philbin to lead the FDO segment

The company also launched a clearance event to liquidate slow moving

inventory. The clearance is expected to wrap up by the end of 2015. FDO

will be re-stocked with more productive inventory

The clearance has negatively impacted gross margins in the short

term which has mistakenly raised some concern among investors

Finally, management noted that many FDO stores were disorganized,

messy and dingy. FDO stores will be revitalized and made cleaner and

brighter which should greatly improve the shopping experience. This is

the kind of common sense retail 101 that has made Dollar Tree a

successful retailer for decades

o Dollar General went through a similar turnaround from 2006 to 2010 when it was

taken private by KKR

KKR closed under-performing DG stores, replaced low-productivity

inventory and made investments to improve the shopping experience

DG also faced short term margin pressure, but was able to power through

and come out a better, more valuable company despite the 2008 recession

Dollar Tree has an Effective Management Team and Board

Dollar Tree’s management and board have created significant shareholder value over the

past 3 decades and will likely continue to deliver for shareholders

The board is led by the first generation of DLTR co-founders and managers. This

generation has retained a significant amount of equity and is aligned with shareholders to

oversee the company

o One concern is that many of the senior board members are aging and may only

have a few years left of involvement with the company; however, the

management team is still young enough to alleviate this concern

The management team, led by Bob Sasser and Gary Philbin, largely consists of company

veterans who have worked their way up from various middle management roles and

understand the company well

o This crop of executives have done an excellent job over the past 10 years, guiding

DLTR through a significant expansion of its store base and consistently

increasing profitability and EPS

o There is no reason why we should not expect this management team to continue

knocking the ball out of the park on performance

The company’s compensation practices are aligned with shareholder interests

o A majority of compensation is based on restricted stock units which vest over a 3

year period

o Bonus compensation is primarily based on operating income goals set by the

board

9

Valuation

Dollar Tree currently trades at 9.5x PF 2016E EV/ EBITDA and 16.6x PF 2016E P/E

o DLTR trades at a discount to discount retailer peers on both EV/EBITDA and

P/E, despite DLTR’s superior expected earnings growth over the next 2-3 years

The median peer FWD EV/EBITDA multiple is 10.7x

The median peer FWD P/E multiple is 22.3x

The peers are expected to grow earnings ~8% in 2016 vs. ~24% for DLTR

o These multiples are elevated relative to historical levels

Over the last 5 years, the FWD EV/ EBITDA multiple has been closer to

9.0x and over the past 10 years, the multiple has been closer to 8.0x

The current FWD P/E multiple is roughly in-line with historical averages

Key Executives and Board Members

Name Age Bio $ Shares Owned Unvested RSUs Stock Options

Bob Sasser,

Chief Executive Officer

63 - CEO since 2004

- Joined DLTR in 1999

- Former executive at Michaels

$5,908,693 $25,953,919 $4,869,912

Gary M. Philbin,

President and COO

58 - COO since 2007

- President since 2013

- Joined DLTR in 2000

- Former CEO of a grocery chain

$8,470,795 $4,944,937 $0

Kevin S. Wampler,

Chief Financial Officer

52 - CFO since 2008

- Former executive at Finish Line

$8,986,001 $3,187,334 $0

Macon F. Brock, Jr.,

Chairman of the board

73 - Chairman since 2001

- DLTR co-founder and former CEO

$256,274,925 $1,338,727 $9,359,070

J. Douglas Perry,

Chairman Emeritus

67 - Former Chairman

- DLTR co-founder and former CEO

$121,336,690 $0 $0

H. Ray Compton,

Director

72 - Director since 1986

- Former DLTR CFO

$22,826,696 $0 $0

Thomas A. Saunders III,

Lead Independent Director

78 - Director since 1993

- Private equity executive

$177,730,870 $0 $15,559,720

Source: 2015 proxy statement. Equity and option values based on share price as of 12/18/2015.

Relative Trading Value Analysis

Enterprise Market Dividend EV / EBITDA Price / Earnings '16 Sales '16 EBITDA 2015E

Company Name Ticker Value Cap Yield 2015E 2016E 2015E 2016E Growth Growth EBITDA %

Dollar General DG $23,738 $20,814 1.2% 11.1x 10.4x 19.5x 18.0x 7.7% 6.7% 11.3%

Big Lots BIG $2,164 $1,890 2.0% 6.3x 5.8x 13.9x 12.6x 0.7% 7.9% 6.6%

Five Below FIVE $1,729 $1,747 N/A 18.2x 15.2x 36.4x 30.6x 21.6% 19.7% 14.0%

Ollie's Bargain Outlet OLLI $1,211 $985 N/A N/A 12.7x N/A 26.7x N/A N/A N/A

Fred's FRED $579 $571 1.6% 20.3x 10.7x N/A N/A 9.7% N/A 1.4%

Mean $5,884 $5,201 1.6% 14.0x 11.0x 23.2x 22.0x 9.9% 11.4% 8.3%

Median $1,729 $1,747 1.6% 14.6x 10.7x 19.5x 22.3x 8.7% 7.9% 9.0%

Dollar Tree (Pro Forma) DLTR $25,098 $17,866 N/A 11.8x 9.5x 19.8x 16.6x 6.0% 23.7% 10.6%

Source: Capital IQ, Wall Street consensus estimates. Dollar Tree based on base case model. Data as of 12/18/2015.

10

A discounted cash flow analysis implies a share price of $102 for DLTR, 34% higher

than the $76.09 share price on 12/18/2015

o The DCF implies the value of DLTR shares today; however, I believe that DLTR

could be worth as much as $130 by 2018. See the IRR Analysis below

o The DCF uses my base case model financials and assumes a discount rate of 10%

and a long term growth rate of 5% in the terminal year (~9.0x exit multiple)

Based on precedent transactions in the retail industry (see above schedule), a private

buyer would be will to pay ~11.3x LTM EBITDA (excluding synergies), this multiple is

lower than DLTR’s 2015E EV/EBITDA multiple of 12.0x

EV / NTM EBITDA Multiple Price / NTM Earnings Multiple

DLTR DG FDO DLTR DG FDO

10 Yr Average 8.1x N/A 7.9x 10 Yr Average 16.7x N/A 16.6x

10 Yr Median 7.7x N/A 7.7x 10 Yr Median 16.4x N/A 15.7x

5 Yr Average 9.5x 9.2x 8.8x 5 Yr Average 18.2x 16.3x 18.2x

5 Yr Median 9.4x 9.3x 8.2x 5 Yr Median 17.9x 16.2x 16.3x

3 Yr Average 9.9x 9.6x 9.6x 3 Yr Average 18.7x 16.7x 20.3x

3 Yr Median 9.6x 9.5x 9.0x 3 Yr Median 18.1x 16.5x 18.0x

1 Yr Average 11.6x 10.2x N/A 1 Yr Average 21.6x 17.9x N/A

1 Yr Median 11.3x 10.5x N/A 1 Yr Median 21.9x 18.4x N/A

Source: Capital IQ. Data as of 12/18/2015. Dollar Tree is not pro-forma for FDO.

Discounted Cash Flow Analysis

2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E Terminal

Sales 20,099 21,304 22,963 24,836 26,851 28,939 31,124 33,396 35,727 38,084 39,988

Growth % 6.0% 7.8% 8.2% 8.1% 7.8% 7.6% 7.3% 7.0% 6.6% 5.0%

EBITDA 2,129 2,633 3,085 3,492 3,897 4,241 4,608 4,913 5,225 5,537 5,813

Margin % 10.6% 12.4% 13.4% 14.1% 14.5% 14.7% 14.8% 14.7% 14.6% 14.5% 14.5%

Tax Rate 37.5% 37.5% 37.5% 37.5% 37.5% 37.5% 37.5% 37.5% 37.5% 37.5% 37.5%

Taxes 609 787 940 1,075 1,208 1,318 1,434 1,528 1,622 1,717 1,803

Δ NWC 40 37 83 122 137 147 157 168 176 179 188

% of Sales 0.2% 0.2% 0.4% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5%

Capex 920 789 883 963 997 1,035 1,076 1,116 1,124 1,150 1,207

% of Sales 4.6% 3.7% 3.8% 3.9% 3.7% 3.6% 3.5% 3.3% 3.1% 3.0% 3.0%

Unlevered FCF 560 1,021 1,179 1,332 1,555 1,742 1,940 2,102 2,302 2,490 2,615

Period 0.25 1.25 2.25 3.25 4.25 5.25 6.25 7.25 8.25 9.25

Discount Factor 0.976 0.888 0.807 0.734 0.667 0.606 0.551 0.501 0.456 0.414

PV of Cash Flow 547 906 952 977 1,037 1,056 1,069 1,053 1,049 1,031

Sum of PV Cash Flows 9,678 Terminal Value Alternative Terminal Value

Terminal Value 21,657 Long-term growth rate 5.0% Exit Multiple 9.0x

Enterprise Value 31,335 Enterprise Value 52,297 Enterprise Value 52,320

Net Debt 7,233 PV Enterprise Value 21,657 PV Enterprise Value 21,667

Equity Value 24,102

Diluted Shares 235.700 Discount Rate 10.0%

Implied Share Price $102.26 Note: calculated WACC = 5%

Current Share Price $76.09

Upside 34.4%

11

o DLTR’s high leverage and elevated valuation makes a sale of the company less

likely in the near future

o Dollar General was taken private by KKR in 2007 for 9.5x LTM EBITDA

o FDO was acquired by DLTR for 11.3x LTM EBITDA (excluding synergies) or

8.2x LTM EBITDA including announced synergies

Price Target, IRR Analysis and Downside Scenario

An investment in DLTR today can achieve an IRR of 20% over the next 2-3 years based

on a 2018 target stock price of $130

Model assumptions:

o DLTR sales growth driven by 300 – 400 new stores opened per year (at a

decelerating growth rate), same store sales growth of 2.0% (vs. 10 year average of

3.7%) and conversion of 500 FDO stores to DLTR stores in 2015 and 2016

o FDO sales growth driven by 200 – 500 new stores opened per year, same store

sales growth 1% - 2.5%, 330 DOJ store divestment in 2015 and 500 store

conversions to DLTR

Bridge to Target Share Price and IRR

2014 2015E 2016E 2017E 2018E 2019E

DLTR Sales 8,602 9,514 10,751 12,015 13,043 14,072

Growth 10.6% 13.0% 11.8% 8.6% 7.9%

EBITDA 1,275 1,413 1,608 1,817 1,984 2,151

Margin 14.8% 14.8% 15.0% 15.1% 15.2% 15.3%

FDO Sales 10,489 10,585 10,553 10,947 11,793 12,779

Growth 0.9% (0.3%) 3.7% 7.7% 8.4%

EBITDA 521 691 900 1,043 1,183 1,346

Margin 5.0% 6.5% 8.5% 9.5% 10.0% 10.5%

Synergies 0 25 125 225 325 400

PF Sales 19,092 20,099 21,304 22,963 24,836 26,851

Growth 5.3% 6.0% 7.8% 8.2% 8.1%

EBITDA 1,796 2,129 2,633 3,085 3,492 3,897

Margin 9.4% 10.6% 12.4% 13.4% 14.1% 14.5%

Base Case Returns Today 2016E 2017E 2018E

Enterprise Value 27,764 31,430 35,073

Fwd. Mult. 9.0x 9.0x 9.0x

Net Debt 6,005 4,992 3,843

Market Cap 21,759 26,437 31,230

Diluted Shares 236.2 236.7 237.2

Share Price $76.09 $92.12 $111.69 $131.66

Upside 21.1% 46.8% 73.0%

IRR 21.1% 21.2% 20.1%

Dollars in millions. Market data as of 12/18/2015.

12

o DLTR margin driven by operating leverage from increased scale

o FDO margin driven by turnaround in core business leading to EBIT margin

recovering to 8.0% in 2019

o Synergies based on management’s expectations through 2018 and revised 25%

higher in 2019

o No debt is paid early or refinanced

o No shares are repurchased

In a worst case where FDO sales and EBITDA are held flat over the next 5 years, no

synergies are realized and the valuation multiple contracts to 8.0x, an investor today

would lose between 0% and 30%. This is a low probability scenario, but even in this

worst case you wouldn’t lose very much which shows that the investment is asymmetric

Key Investment Risks and Mitigating Factors

Risk of a recession (business cyclicality)

o While retail spending typically falls during a recession, the Dollar Stores are

fairly recession resistant and even slightly counter-cyclical

o During the recession in 2008, the three major dollar stores all saw their same store

sales metrics rise

o The dollar stores also perform well in a good economy as evidenced by their

strong performance in the periods before and after the recent recession

As CEO Bob Sasser commented at the recent Goldman Sachs retail

conference: “In good times, our customers really like the discretionary

product mix that we sell. They spend more on their trips, have more

money in their pocket.”

A Deloitte study found that 93% of consumers planned to maintain

cautious spending habits regardless of the economy’s strength1

o To mitigate the cyclical risk in the stock, I assumed a normalized valuation

multiple of 9.0x vs. the current 9.5x and haircut future unit growth and same store

sales growth

The threat from increased competition

o The dollar store category has grown over the past few decades due to the major

chains opening thousands of new stores

1 “Dollar & Variety Stores in the US”, IBISWorld Industry Report, March 2015.

Downside Scenario

Worst Case Returns Today 2016E 2017E 2018E

Enterprise Value 18,728 20,069 21,406

Fwd. Mult. 8.0x 8.0x 8.0x

Net Debt 6,005 4,992 3,843

Market Cap 12,723 15,077 17,563

Diluted Shares 236.2 236.7 237.2

Share Price $76.09 $53.86 $63.70 $74.04

Upside (29.2%) (16.3%) (2.7%)

IRR (29.2%) (8.5%) (0.9%)

Dollars in millions. Market data as of 12/18/2015.

13

o Overexpansion by the dollar stores chains is a real risk as the category matures.

Also, big box chains such as Walmart are starting to open smaller-format stores

o However, the threat of additional dollar stores and smaller format versions of big

box stores is not new and industry players see continued category growth for the

foreseeable future. DLTR management believes it can accommodate 9,000 DLTR

stores and 11,000 FDO stores in the U.S. and Canada, 40% more stores than today

Continued positive same store sales growth trends across the industry have

proven that there is sufficient demand for dollar stores

o DLTR has sophisticated models and disciplined metrics for selecting sites to open

new stores and management has a proven track record of earning high returns on

invested capital while investing in new stores

The Dollar Tree banner dominates the $1 category and is insulated from

competition. DLTR’s scale provides it a sustainable competitive

advantage at the $1 price point

The Family Dollar banner is more susceptible to competition because it

relies more on grocery sales; however, FDO stores tend to be located in

urban and rural areas where competitors have not been successful

The threat from e-commerce

o Dollar stores face low risk from e-commerce cannibalizing sales because they are

convenience oriented. Customers typically make more trips to dollar stores and

purchase fewer items per trip

o The low price point makes shipping more expensive and consumables and

grocery items have very low e-commerce penetration

o A large segment of the customer base is low income and pays with EBT cards.

This payment is not widely supported for online shopping. Also, this customer

demographic is less likely to shop online in general

The risk of failing to realize expected synergies or turnaround Family Dollar

o I believe the synergy estimates are very conservative when compared against

precedent retail acquisitions. Management has recently reaffirmed the synergy

estimates and even mentioned the possibility of exceeding them

o Turning around Family Dollar will likely be trickier than achieving the synergies

because DLTR’s management team has to study the business, understand its

failings, and possibly make strategic changes to the model

DLTR’s management has already made significant progress in improving

FDO stores. Many of the changes are common sense retailing such as

keeping the stores clean and making price investments. Some of the

changes such as better training store managers and optimizing the store

footprint will be more challenging but DLTR’s management has already

taken a crack at those challenges

I would not bet against the track record of DLTR’s management and board

o A worst case scenario illustrated earlier where FDO does not grow, FDO does not

become more profitable, DLTR realizes no synergies, and the valuation multiple

contracts to 8.0x, implies negative returns between 0% and 30%

14

Concluding thoughts

An investment in Dollar Tree today is a compelling opportunity to invest alongside a

best-in-class management team as they create value from a very shareholder friendly

transaction

While some view the Family Dollar transaction with a degree of skepticism due to its size

and complexity, a common sense analysis of its various components shows that the

Dollar Tree team is extremely well positioned to squeeze out synergies and improve

earnings

The valuation of Dollar Tree is reasonable in both relative and absolute terms. It is

surprising that DLTR trades at a discount to its peers given its superior operating history

and expected earnings growth

For Dollar Tree being a large cap stock in choppy equity markets, the prospect of

achieving a 20% IRR over the next 2-3 years is very attractive

Even if Dollar Tree falls short in some areas, there is very little risk of losing money

because of the stability of the core business, the reasonable equity valuation, and the

competence of the deep-benched management team and board

15

Historical Income Statement

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Sales 3,126 3,394 3,969 4,243 4,645 5,231 5,882 6,631 7,395 7,840 8,602

Growth % 8.6% 17.0% 6.9% 9.5% 12.6% 12.4% 12.7% 11.5% 6.0% 9.7%

Cost of Sales 2,014 2,222 2,612 2,782 3,053 3,374 3,742 4,252 4,742 5,051 5,568

Gross Profit 1,113 1,172 1,357 1,461 1,592 1,857 2,140 2,378 2,653 2,790 3,034

Margin % 35.6% 34.5% 34.2% 34.4% 34.3% 35.5% 36.4% 35.9% 35.9% 35.6% 35.3%

SG&A 477 507 607 655 718 805 902 963 1,051 1,079 1,165

Advertising Expense 11 12 11 8 7 8 11 14 14 15 18

SBC 0 2 7 11 17 22 28 32 36 37 38

EBITDAR 624 651 733 786 851 1,022 1,199 1,370 1,553 1,659 1,813

Margin % 20.0% 19.2% 18.5% 18.5% 18.3% 19.5% 20.4% 20.7% 21.0% 21.2% 21.1%

Rent Expense 202 227 263 297 324 351 383 424 458 498 538

EBITDA 423 425 470 490 528 671 816 946 1,095 1,161 1,275

Margin % 13.5% 12.5% 11.8% 11.5% 11.4% 12.8% 13.9% 14.3% 14.8% 14.8% 14.8%

D&A 129 141 159 159 162 158 160 164 175 191 206

EBIT 294 284 311 330 366 513 656 782 920 970 1,069

Margin % 9.4% 8.4% 7.8% 7.8% 7.9% 9.8% 11.2% 11.8% 12.4% 12.4% 12.4%

Net Interest Expense 5 9 8 11 7 5 6 3 3 15 80

Other 0 0 0 0 0 0 21 (0) (62) 1 34

EBT 288 275 303 320 359 508 630 780 979 954 954

Taxes 108 101 111 119 130 187 233 291 360 358 355

Tax Rate 37.4% 36.8% 36.6% 37.1% 36.1% 36.9% 36.9% 37.4% 36.7% 37.5% 37.2%

Net Income 180 174 192 201 230 321 397 488 619 597 599

Norml. Net Income 180 172 189 200 224 317 407 487 573 597 618

Margin % 5.8% 5.1% 4.8% 4.7% 4.8% 6.1% 6.9% 7.3% 7.8% 7.6% 7.2%

Diluted Shares 342.000 326.100 311.400 289.200 272.200 270.000 256.000 242.400 230.700 219.100 207.000

Diluted EPS 0.53 0.53 0.62 0.70 0.84 1.19 1.55 2.01 2.68 2.72 2.89

Norml. Diluted EPS 0.53 0.53 0.61 0.69 0.82 1.18 1.59 2.01 2.49 2.72 2.98

EPS Growth 0.1% 15.3% 13.7% 19.3% 42.5% 35.2% 26.5% 23.7% 9.6% 9.6%

16

Historical Balance Sheet

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Cash and Equivalents 318 340 307 81 364 599 486 288 400 268 864

Merchandise Inventories 615 577 605 641 676 680 803 867 972 1,035 1,036

Deferred Tax Assets 8 11 11 17 8 6 16 26 23 19 28

Prepaid Expenses and Other 29 17 45 49 25 20 28 28 79 57 67

Total Current Assets 970 944 968 789 1,073 1,306 1,333 1,209 1,474 1,379 1,995

PP&E 685 682 715 744 710 714 741 825 961 1,094 1,211

Deferred Tax Asset-net 0 0 0 39 33 35 38 17 28 24 31

Goodwill 0 0 133 133 133 133 173 173 173 169 165

Intangibles, Net 129 129 0 0 0 0 0 0 0 0 0

Other Assets 8 44 66 83 86 102 95 104 116 106 167

Total Assets 1,793 1,798 1,882 1,788 2,036 2,290 2,381 2,329 2,752 2,772 3,567

Accounts Payable 124 136 198 200 193 220 261 287 347 394 434

Income Taxes Payable 34 42 43 43 47 49 64 63 80 47 43

Other Current Liabilities 105 99 132 144 153 190 191 216 236 232 385

Total Current Liabilities 263 277 373 387 392 458 516 566 662 674 862

Total Debt 282 269 269 269 268 268 267 266 271 770 757

Deferred Tax Liabilities 42 24 2 0 0 0 0 0 0 0 0

Other Liabilities 41 57 71 88 108 120 124 138 146 152 157

Income Taxes Payable 0 0 0 55 15 14 15 16 6 6 7

Total Liabilities 628 626 715 799 783 861 922 984 1,085 1,601 1,782

Common & APIC 179 13 1 1 39 1 1 1 3 13 45

Retained Earnings & AOCI 985 1,160 1,167 988 1,214 1,428 1,458 1,344 1,665 1,158 1,740

Total Shareholders Equity 1,164 1,172 1,168 988 1,253 1,429 1,459 1,345 1,667 1,171 1,785

Total Liabilities & Equity 1,793 1,798 1,882 1,788 2,036 2,290 2,381 2,329 2,752 2,772 3,567

Historical Cash Flows Statement

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Net Income 180 174 192 201 230 321 397 488 619 597 599

Depreciation and Amortization 129 141 159 159 162 158 160 164 175 191 206

Stock Based Compensation 0 2 7 11 17 22 28 32 36 37 38

Other 36 (4) (26) (26) 68 26 26 16 (87) (0) (23)

Δ Working Capital:

Merchandise Inventories (90) 39 (6) (36) (35) (4) (127) (65) (104) (68) (6)

Accounts Payable 9 11 54 2 (8) 27 28 27 59 47 42

Income Taxes Payables (3) 8 2 47 (37) 2 15 (1) 16 (32) (5)

Other Current Liabilities 15 (6) 32 9 6 31 (9) 25 20 (3) 88

Prepaids and Other 0 0 0 0 0 0 0 0 (57) 26 (12)

Operating Cash Flow 277 365 413 367 403 581 519 687 678 794 927

Capital Expenditures (182) (139) (175) (189) (131) (165) (179) (250) (312) (330) (326)

Cash Acquisitions (7) (4) (58) (7) (0) 0 (50) 0 0 (0) 0

Cash Dispositions 0 0 0 0 0 0 0 0 61 (1) 2

Marketable Securities and Other (127) (93) 43 173 30 (48) (146) 164 (11) 6 9

Investing Cash Flow (315) (236) (191) (23) (102) (213) (374) (86) (262) (325) (315)

Proceeds (Paydown) of Debts 95 (1) (1) (1) (1) (0) (15) (2) 6 499 (13)

Stock Based Comp. 15 11 46 85 24 30 28 25 31 16 10

Share Buybacks (49) (180) (248) (473) 0 (191) (417) (646) (340) (1,112) 0

Debt Issuance Costs 0 0 0 0 0 0 0 0 0 0 (12)

Financing Cash Flow 61 (170) (203) (389) 23 (161) (404) (623) (303) (598) (15)

FX 0 0 0 0 0 0 (1) (0) (1) (4) (1)

Changes in Cash 22 (41) 19 (44) 324 207 (260) (23) 112 (132) 596

Documents

Dollar Tree, Inc. (NASDAQ:DLTR) Investment Memo 12/18/15 · 12/24/2015 · Dollar Tree, Inc. (NASDAQ:DLTR) – Investment Memo – 12/18/15 Recommendation: Long Dollar Tree (NASDAQ:DLTR)