Dollarama Inc. Stock Report

Dollarama Inc.

Revenues per share growth appears relatively flat prior to 2011 but that is due the issuance of additional shares at the IPO in late 2009. Earnings per share growth has been very strong since 2009. Share buy backs have added to the recent growth rate. The book value per share (green line) has declined rapidly only because of the very large program of buying back shares at prices so far above book value.

Dollarama Inc. (DOL, Toronto)
RESEARCH SUMMARY
Report Author(s):  InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) hold no shares
Based on financials from: Jan ’17 Y.E. +Q2 ’18
Last updated: 25-Nov-17
Share Price At Date of Last Update: $162.03
Currency: $ Canadian
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): (lower) Sell rated at $162.03
SUMMARY AND RATING: This “cell” summarizes information from other cells below. The graph of revenue and earnings per share growth since 2007 shows very strong growth in earnings per share. The revenue per share growth has also been extremely strong. The economics of the business are very good as it can open stores for about $700,000 which generate bottom line profit after taxes of about $405,000 per year. The Value ratios arguably indicated a rating in the Sell range due to the high share price. The company is currently valued at almost $18 million per store (counting equity plus debt) which strikes us as very high, even considering that much of the value may be for the ability to add new stores quite cheaply. On the basis of assets the shares are clearly very expensive indeed. In the past, this high value per store figure was part of the reason we were not prepared to buy the shares but that was a mistake. The insider trading signal is moderately negative. The company is extremely well managed (by the founding family). The outlook is that the company may grow earnings at about 16% based on store additions, same store sales growth and share repurchases although it could grow faster if economies of scale continue to increase. However, it growth could temporarily be slowed by higher minimum wages in January.  With a P/E of 39 it is pricing in continued robust growth It does well on the Buffett tenets although importantly it does not appear to be selling at a bargain price. Overall we rate this a (lower) Sell at $162.03
DESCRIPTION OF BUSINESS: Dollar store chain in leased premises. As of July 30, 2017 Dollarama has 1125 stores. All stores are leased. There are also 5 warehouses and 2 distribution centers all in Quebec. These are also leased except for the newest large distribution center. Headquarters are in Montreal. It’s by far the dominant dollar store in Canada.  With an enterprise value of $20,060 million, this represents (an astonishing) $17.8 million per store. Obviously some (perhaps a good deal) of the value represents the ability to put in new stores at a modest cost (of about $0.7 million). The stores average about 10,000 square feet (say 100 feet by 100 feet). It offers products at the low standard price points of $0.69 $1.00, $1.25, $1.50, $2.00, $3.00,$3.50 and $4.00). It sources its products at a very low cost (more than half the inventory is sourced directly from low-cost countries including, mostly, China.) Despite its low prices it actually has a high gross margin at about 39%. And its net profit margin is exceptionally high for retail at a recent 15.5%. As of early 2017 there were about 18,300 employees with about 450 in head office or in field management.
ECONOMICS OF THE BUSINESS: (Last updated for Q2 fiscal 2018) The economics of the business are exceptionally good in that it can open a new store and achieve a two year payback. Also it has strong sales on products which it is marking up about 64%. The overall net profit per dollar of sales is 15.5% which is very (very) high for a retail operation. The company has been able to pay out all of the invested capital and all of the retained earnings and finance the company completely with debt because the profitability is so strong that debt investors are willing to finance on this basis.
RISKS: See annual report for risks. This appears to us to be a relatively low risk operation. The major risk is probably that dollar store competitors emulate their successful business model. Also there is a risk that Walmart could open a dollar store section in its stores. Rising rent lease costs may also be a risk. Also rising minimum wages and payroll taxes. There are risks associated with product liability.
INSIDER TRADING / INSIDER HOLDING: Checking insider trading from March 1, 2017 to November 25, 2017: Four insiders exercised options and sold shares mostly at $around $115. One insider sold 25,000 shares at $113 to $134 but retained 675,000 shares. Overall this insider trading signal is moderately negative. As to insider holding, the founder owns 2.5 million shares directly worth some $404 million dollars as well as 4.6 million shares ($749 million dollars) in his family foundation. His son, now CEO owns 1.1 million shares worth $172 million. One executive owns $109 million dollars worth. This insider holding is a positive indicator.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand (pass, a simple retail operation), has favorable long-term economics due to cost advantages or superior brand power (pass due  to leading market position and profit record), apparently able and trustworthy management (pass due to strong track record), a sensible price – below its intrinsic value (fail), Other criteria that have been attributed to Buffett include: a low  debt ratio (fail), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass)
MOST RECENT EARNINGS AND SALES TREND: The earnings per share growth in the most recent four quarters starting with Q3 fiscal 2017 that ended July 30, 2017 was 30%, 21%, 24% and 18%. Growth in revenues per share for the same four quarters was 17%, 17%, 18% and 20%. The recent trend is therefore extremely strong.
COMPARABLE STORE SALES: in the most recent four quarters starting with Q2 fiscal 2017 that ended July 30, 2017, same-store sales growth was 6.1%, 4.6%, 5.8%, and 5.1%.  For fiscal 2017, same store sales were up 5.8%, For fiscal 2016, same store sales were up 7.3%, For fiscal 2015, same store sales growth was 5.7%. For fiscal 2014 same store sales were up 3.8%, For fiscal 2013, same-store sales were up 6.5%, for fiscal 2012 same store sales were up 5.4% for fiscal 2011 same store sales were up 7.3%.
Earnings Growth Scenario and Justifiable P/E: The recent P/E of 39 can only be justified by continued high growth. With today’s low interest rates it could be justified with earnings growth of 10% per year for ten years followed by much slower growth in the 6% range.  Also 17% for five years and then a terminal P/E of 24 would justify this 39 P/E.
VALUE RATIOS: Analyzed at a price of $162.03. The dividend yield is quite modest at 0.3% and this is despite the fact that the dividend has been increased. The dividend pay-out ratio is only 10% of earnings. (The low dividend is wise as the company has had better uses for the cash). Book value per share is negative but that is because the earnings are so strong that the company has paid out all the equity mostly through share repurchases. This company is valued for its earnings and not its assets. The P/E is unattractively very high at 39. The ROE is undefined due to the negative book equity. Intrinsic value is calculated at $65 if earnings grow at only 7% per year and the P/E recedes to 15 in five years (which are very conservative assumptions) and at $124 if earnings grow rapidly at 15% per year and the P/E recedes to 20 in five years. And $162 if earnings grow at 17% per year and the P/E recedes to only 24. The most recent earnings per share growth has been about 24%. Based on same store growth and the addition of stores we might expect growth of around 12% in the short term although it could be 16% due to share buy-backs or even higher with increased economies of scale and due to share buy-backs. However, higher minimum wages could lower growth starting in January 2018. Overall this is a very strong and profitable company but it is selling at an elevated P/E ratio. This would indicate perhaps a (lower) Sell rating.
SUPPORTING RESEARCH AND ANALYSIS
Symbol and Exchange: DOL, Toronto
Currency: $ Canadian
Contact: michael.ross@dollarama.com
Web-site: www.dollarama.com
INCOME AND PRICE / EARNINGS RATIO ANALYSIS
Latest four quarters annual sales $ millions: $3,110.7
Latest four quarters annual earnings $ millions: $482.6
P/E ratio based on latest four quarters earnings: 39.2
Latest four quarters annual earnings, adjusted, $ millions: $482.6
BASIS OR SOURCE OF ADJUSTED EARNINGS: In some quarters we adjusted for foreign exchange gains or losses and other items identified by management and for a one-time payroll tax on option exercise in  fiscal 2013.
Quality of Earnings Measurement and Persistence: Earnings are high quality in that they are earned in cash and there is relatively little in the way of estimated costs such as depreciation. Earnings persistence has been very strong as well with earnings growing steadily.
P/E ratio based on latest four quarters earnings, adjusted 39.2
Latest fiscal year annual earnings: $445.6
P/E ratio based on latest fiscal year earnings: 42.5
Fiscal earnings adjusted: $445.6
P/E ratio for fiscal earnings adjusted: 42.5
Latest four quarters profit as percent of sales 15.5%
Dividend Yield: 0.3%
Price / Sales Ratio 6.09
BALANCE SHEET ITEMS
Price to (diluted) book value ratio: –                                  312.95
Balance Sheet: (last updated Q2 fiscal 2018). Assets are comprised as follows:  44% goodwill and trademarks, 25% inventories, 24% property and equipment (shelving, store equipment ), 4% is cash and 1% accounts receivable.  On the liability and equity side these assets are financed as follows: 78% debt, 15% that is mostly accounts payables and also included other payables, 5% deferred income tax and 4% deferred tenant inducements (which add to income as they are amortized away) and an equity deficit of 3%. This balance sheet appears quite weak on its face. However if it is considered that the negative book equity has a market value of $18.6 billion, then the balance sheet would look very strong on a marked to market basis. (On that basis the assets would consist largely of goodwill.)
Quality of Net Assets (Book Equity Value) Measurement: Other than inventories, this is not an asset intensive business. The accounting book value is negative which is basically meaningless. The company is valued for its earnings and not assets. If earnings were to evaporate, the assets would have little value.
Number of Diluted common shares in millions:                                 114.7
Controlling Shareholder: Technically there is no controlling shareholder and it is therefore effectively controlled by the founding family and the other managers who collectively owned 7.1% of the company as of mid 2017.
Market Equity Capitalization (Value) $ millions: $18,585.7
Percentage of assets supported by common equity: (remainder is debt or other liabilities) -3.1%
Interest-bearing debt as a percentage of common equity -2482%
Current assets / current liabilities: 2.0
Liquidity and capital structure: Liquidity seems strong despite the fact that the balance sheet is financed with debt and no equity. DBRS has rated its senior debt at BBB which is a relatively strong rating.
RETURN ON EQUITY AND ON MARKET VALUE
Latest four quarters adjusted (if applicable) net income return on average equity: 502.6%
Latest fiscal year adjusted (if applicable) net income return on average equity: 157.2%
Adjusted (if applicable) latest four quarters return on market capitalization: 2.6%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE
5 years compounded growth in sales/share 18.4%
Volatility of sales growth per share:  Strong and steady
5 Years compounded growth in earnings/share 26.4%
5 years compounded growth in adjusted earnings per share 26.4%
Volatility of earnings growth:  Very Strong Growth
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? Yes
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 140.7%
More conservative estimate of compounded growth in earnings per share over the forecast period: 7.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 15.0%
OUTLOOK FOR BUSINESS: With same-store sales growth running at about 5.5% and with the store count increasing by about 6% and with the share count being reduced at the rate of about 5% per year and with some economies of scale, we might expect near-term growth in the range of 16% or somewhat higher. Longer term it should continue to grow but likely at a lower pace. It would seem logical that at some point saturation in Canada would be reached and/or that mass merchants will begin to lower prices to compete or other dollar store chains will begin to gain market share. In addition it is providing advice and import services to a small dollar store chain in South America and this could add to the growth.
LONG TERM PREDICTABILITY: The ability to maintain its very strong growth is not easy to forecast especially beyond a few years but it seems reasonable to project that it can continue to grow profits over the years.
Estimated present value per share: We calculate  $65 if earnings per share grow for 5 years at the more (probably very) conservative rate of 7% and the shares can then be sold at a far lower P/E of 15 and $124 if earnings per share grow at the more optimistic (and more aggressive but still far lower than historic) rate of 15% for 5 years and the shares can then be sold at a P/E of 20. Both estimates use a 6.5% required rate of return.
ADDITIONAL COMMENTS
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (Pass, has some barriers due to size). No issues with powerful suppliers (pass). No issues with dependence on powerful customers (pass), No potential for substitute products (pass) No tendency to compete ruinously on price (pass). Overall this industry appears to be attractive for a large incumbent.
COMPETITIVE ADVANTAGE: While there may be nothing proprietary about their approach, the following appear to be competitive advantages: All sales are final resulting in lower costs as opposed to allowing returns. They are 4.8 times larger than their nearest Canadian dollar store competitor, (Dollar Tree) which provides economies of scale in purchasing. Clean, modern, well located stores. About half of the merchandise is direct sourced from low-cost foreign jurisdictions with the majority from China. Consistent products are carried as opposed to surplus or liquidation type items. The company is very popular with consumers and has little or no need to advertise except when opening new locations. Lack of advertising is a cost advantage.
COMPETITIVE POSITION: (Updated for Q2 2018) Dollarama is the leading dollar store chain in Canada by a very wide margin. It has almost five times the number of stores of its closest direct competitor.
RECENT EVENTS: Dollarama began accepting credit cards at all locations on May 1, 2017. A large new distribution center was recently completed. Continues to buy back shares aggressively. The dividend has increased but remains relatively small. Continues to open stores at a rate that increased the store count by  6% in fiscal 2017, 8% in fiscal 2016, 9% in fiscal 2015, 11% in the 2014 fiscal year and 11.5% in fiscal 2013.
ACCOUNTING AND DISCLOSURE ISSUES: We did not identify any concerns. It is annoying that under standard accounting practices they do not appear to separately disclose their store lease expenses. Cost of goods sold include not only the actual cost of goods sold but also store lease and merchandise transportation costs. But overall the disclosure appears to be very good.
COMMON SHARE STRUCTURE USED: Normal, one vote per share.
MANAGEMENT QUALITY: Management has grown this company dramatically and has achieved very high returns on equity  and is of high quality. This appears to be one of the very best managed companies in Canada.
Capital Allocation Skills: Management appears to have made good choices in investing its capital and in its financing. Share buy backs have reduced the share count by about 24% since the IPO despite shares issued under stock options. The buyback prices in the past four years averaged $41, $52, $81 and $95 in fiscal 2017. Recent buy backs were at as high as $141. Given a recent price of $162 this use of cash has benefited the continuing share owners. The dividend is modest at 11% of earnings but using funds for buybacks rather than higher dividends has been more beneficial. The company’s choice to lease stores rather than own them appears to have resulted in a far higher return on capital.
EXECUTIVE COMPENSATION: (Updated for Q2 fiscal 2018) Compensation is perhaps generous ranging from $1.9 million to $4.0 million for the five top officers. However, it may be appropriate given the earnings level and growth. Given earnings of $446 million in fiscal 2017, executive compensation of this level is not a concern.
BOARD OF DIRECTORS: There are nine members. They have good retail experience. Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. This group seems good on that score as it includes two members of the founding family and two outsiders with a relatively significant share ownership, and also considerable retail experience on the Board. Also two former member of Bain Capital remain on the Board which gives expertise in financial management including use of debt leverage.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
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