Despite Bleak 2023 Profit Guide, We Think Dollar Tree Prudently Boosting Long-Term Brand Investment

No-moat Dollar Tree DLTR announced a sweeping, pull-forward investment of $430 million in fiscal 2023 and materially boosted its near-term capital expenditure expectations (to $2 billion or 6.5% of sales, from the 4% average it has expended historically). Even though we view such spending as prudent, these efforts stand to strangle near-term profitability, overshadowing the firm’s otherwise solid fourth-quarter finish (a 7.4% comparable-store sales increase and 70 basis points of gross margin expansion to 30.9%).

Against the backdrop of ongoing product expansion, price investment, and efforts to revitalize its lagging Family Dollar arm, CEO Richard Dreiling (who took the helm Jan. 29 but previously ran industry-peer Dollar General) seems intent on enhancing the opportunity for its workforce (increasing wages by $2 hourly for associates), which we see as a judicious means to bolster the in-store experience and curb crippling employee turnover. Further, management aims to direct resources toward store repairs, maintenance, renovations, new store openings, and IT. While we don’t think this will unlock an improved competitive position, we believe this spending is necessary in light of the ultra-competitive market in which it plays.

However, guidance for a low-teens percentage increase in operating expenses with no anticipated top-line benefit in fiscal 2023 crimps our operating margin forecast of 8% by around 150 basis points, even as our preprint revenue forecast fits within Dollar Tree’s $29.9 billion-$30.5 billion range. As such, we plan to lower our $118 fair value estimate by a mid-single-digit percentage, but still view shares as expensive. While these initiatives could ultimately aid its sales and profit track, we don’t intend to drastically alter our long-term forecast (for 5% average sales growth and 31.5% gross margins) until the company provides more context at its June investor event.