Dollarama Stock Has a Valuation That Doesn’t Make Cents

Although Dollarama Inc. (TSX: DOL) continues to deliver strong operating performance, the stock seems to have run ahead of its fundamentals

SmallCapPower | September 22, 2017: Dollarama Inc. (TSX: DOL) is Canada’s largest discount retailer, selling a variety of merchandise at its 1,100 retail stores across Canada. The Company’s stellar financial performance since its IPO has driven the stock price up multifold, which seems ahead of its future potential. Growth in the long term would be largely in line with the overall retail industry as growth from the current large base would be lower. Headwinds such as rising interest rates and appreciating Canadian dollar could also play spoilsport. Short-term and value investors should be cautious about the stock at current levels.

Investment Thesis

  • Canada’s largest discount retailer with more than 1,100 stores across Canada
  • Notwithstanding the strong financial and operating performance, valuations look stretched at current levels
  • Headwinds such as rising interest rates and correcting housing market could slow down operating performance

Value retailer operating more than 1,000 stores across Canada

Dollarama is Canada’s largest discount retailer operating 1,125 stores (as of July 2017) across Canada. The Company’s primary strategy is to offer compelling value for its primary target customer, middle class. As part of this, Dollarama offers a broad assortment of everyday consumer products, general merchandise and seasonal items, including private label and nationally branded products, at compelling values – merchandise is sold in individual or multiple units at nine select fixed price points ranging from $0.82 to $4.00. This unique and focused approach has driven significant growth in store count and financials over the past several years, with stores reaching 1,100 in fiscal 2016 from ~600 in Fiscal 2009 and revenues reaching $2.97 billion in FY2016 from $1.2 billion in FY2009.

But growth seems to have peaked: Over the past decade, the Company’s operations and financials have improved significantly and growth henceforth on this large base could be lower. Management notes that the store count over the next 10 years could be 1,400-1,700, which highlights that the expansion in store count could be limited which in turn could impact the revenue growth going forward.

Valuations look stretched, at least in the short term

Since the 2009 IPO price of ~$10, shares of Dollarama have grown multifold and currently trade $136.43, driven primarily by strong growth in earnings that have consistently beaten analysts’ expectations. Post the 2QFY18 result beat, shares rose ~10% and recently (September 8, 2017) hit an all-time high of $139.50. Sales for 2QFY18 rose 11.5% to $812.5 million, driven by strong comparable store sales growth of 6.1% versus 5.7% in the prior year quarter. Dollarama opened 17 net new stores during the quarter compared to 13 net new stores in the prior year quarter. Notwithstanding the strong performance, the strong run up of 39% YTD makes it the most expensive retail stock and warrants a pause at least in the near term.

As shown in the table below, Dollarama trades at a PE of 33.0x compared to the peer mean of 17.8x while on a Price/sales basis, the Company trades at 4.68x almost nine times the peer mean of 0.56x.

Additionally, the EPS growth of 30% for 2QFY18 came in on aggressive share buybacks and the resultant reduction in outstanding shares. Dollarama has also taken on more debt ($400 million additional over past six months) that has increased ROE at the expense of risks such as higher interest outgo. As mentioned above, growing on this large base could be difficult and the growth rates seen in the past are not sustainable.

Consumer spending might be peaking

Retail stocks in Canada overall have benefitted of late from lower interest rates, a weak Canadian dollar, a strong housing market and favourable employment data. However, this favourable scenario could be reversing or might have already peaked. The central bank of Canada hiked rates in July 2017, for the first time since 2010, while the Loonie currently trades at a one-year high of 0.819 to the USD.

Recent insider selling hints at an overvalued stock

Though small, insider selling indicates that the people who know the business best think that the shares may have peaked. On September 12, 2017, Geoffrey Peter Robillard sold 5,000 shares at an average price of C$133.99, for a total value of $669,950.

Outlook

Although Dollarama has and continues to deliver strong operating performance, the stock seems to have run ahead of its fundamentals. Short-term and value investors should be cautious about the stock at current levels.

Disclosure: Neither the author nor any of the principals at SmallCapPower, or their family members, own shares in the company mentioned above.

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