We highlighted Dollar Tree (DLTR) as a key stock to watch this week, among a dozen others. For those who may not know, Dollar Tree is discount store chain that sells its items for $1 or less. It operates in the United States and Canada and is one of our top plays in the space. As you probably know, or at least surmised from the way it operates, Dollar Tree competes for business in the low-end retail markets. You might be surprised, but it offers everything from food and snacks to electronics and books. It has significant deals in place with manufacturers and distributors to run a very profitable business. That said, the stock is reeling a bit today, so let’s dive in and see how things are going.

Source: Yahoo finance

Strong property management

One of the things we love about this company is that it wastes no time shutting down losing operations and opening up new shops in high demand areas. During the quarter, Dollar Tree opened 137 stores, expanded or relocated 8 stores, and closed 46 stores. Retail selling square footage at fiscal year-end was approximately 116.6 million square feet, and we think it moves higher in 2018. But did this activity help with sales?

Sales in Q4

Well, sales were up nicely. Consolidated net sales increased 12.9% to $6.36 billion from $5.64 billion in the prior year’s fourth quarter. We were also pleased with the action in comparable sales. We saw that enterprise same-store sales increased 2.4% on a constant currency basis

This same-store sales growth was driven by increases in average ticket and comparable transaction count. Same-store sales for Dollar Tree increased 3.8%. Same-store sales for Family Dollar banner increased 1.0%. Did this growth lead to profits rising?

Expenses and profit

We were pleased that gross profit increased 16.3% to $2.10 billion compared to $1.81 billion in the prior year’s fourth quarter. As a percentage of sales, gross margin increased to 33.0% compared to 32.1% in the prior year. This happened because of lower merchandise costs, markdowns and occupancy costs as a percentage of sales.

In addition, selling, general and administrative expenses were down as a percent of sales. They came in at 21.0% of sales compared to 21.7% of sales in the prior year's fourth quarter. When we factor in the gross margins as well as selling expenses, we saw a boost in income.

Income metrics

Operating income increased 30.5% to $765.6 million compared with $586.5 million in the same period last year and operating income margin increased to 12.0% of sales in the current quarter from 10.4% in last year’s quarter. After factoring in the impact of tax reform, net income widened.

Net income compared to the prior year's fourth quarter increased $718.3 million to $1.04 billion and diluted earnings per share increased 221.3% to $4.37 compared to $1.36 in the prior year’s quarter. The extra week of business added $0.21 per share of income. Of course, if we account for items on a comparable basis adjusted earnings per share for the quarter was $1.89. This actually was a miss against estimates, and why shares are falling. However, we believe the selloff is overdone.

A look to 2018

We think the selloff is overdone as we are expecting a strong 2018. Looking ahead to the first quarter we see net sales in the range of $5.55 billion to $5.64 billion, based on a low single-digit increase in same-store sales, and continued strength at the Dollar Tree stores. Considering gross margin expansion, we see earnings per share of $1.19 to $1.26.

For the year we are targeting sales of $22.75 billion to $23.15 billion. This estimate is based on a low single-digit increase in same-store sales and the present trajectory of the company.  As for earnings, we are looking for $5.27 to $5.65.

Take home

Dollar Tree remains one of our top plays in this space. Although the stock is getting hit hard today, the company is gaining traction from the work that has been done over the past several years. If management can execute on its strategies, we expect the momentum of the last few years to grow.