dollarama inc. - VERITAS Investment Research

September 19, 2012
DOLLARAMA INC.
TSX - DOL
Previous Close: C$58.11
Another Look at Dollarama
Retail & Consumables
Kathleen Wong
[email protected]
Varun Anand
[email protected]
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DOLLARAMA INC.
1
ANOTHER LOOK AT DOLLARAMA
Dollarama Inc. (“Dollarama”) has been the star of Canadian retail since going
public in October 2009. In the past we have been concerned with
Dollarama’s store growth aspirations, the competitive intensity of the
Canadian market as well as the impact of a multiple price point strategy on
Dollarama’s value proposition. However, Dollarama’s business model has
proven to be more resilient than we anticipated, as the company has
continued to deliver strong top line and bottom line growth. After an extensive
review of our previous thesis, we believe the company has upside in the near
term, particularly over the next 12 to 18 months. As a result, we now rate the
company as a BUY for the following reasons:

Our proximity analysis of the Canadian dollar store industry shows there
are roughly 468 optimal locations for new dollar stores to open before the
market experiences significant saturation. If we assume Dollarama and
Dollar Tree grow at a combined rate of 120 stores per year, the Canadian
market can handle roughly four additional years of aggressive growth. We
expect Dollarama will comfortably reach its goal of 900 to 1,000 total
stores by F2017, which positions the company well to cherry pick the best
locations over the next several years before they become scarce;

Our price survey in August 2012 shows prices for items in the $1.00 range at
Dollarama have been flat since August 2010, while prices for the same
items have increased 13% at Walmart. The total basket price at Dollarama
and Dollar Tree were nearly equal, implying Dollarama remains
competitively priced with Dollar Tree despite deriving more than 50% of its
sales from items above $1.00. We believe Dollarama’s multiple price point
strategy has not been utilized as a means to pass through inflation, and,
as a result, Dollarama’s value proposition remains stellar;

With the introduction of items at $2.50 and $3.00 in July 2012, Dollarama
now offers many items that are distinct from its current offering, and, in
many cases, offer steep discounts compared to retailers such as Walmart
and Amazon. Given Dollar Tree’s single price point strategy, Dollar Tree will
be unable to offer the same assortment and breadth of products as
Dollarama. We believe Dollarama can continue to selectively introduce
higher price points as a means to drive same store sales growth (“SSSG”),
while maintaining its core offering of items in the $1.00 range. We estimate
Dollarama will achieve SSSG of 7% in both F2013 and F2014;

Despite facing high unemployment and rising debt levels, Dollarama has
consistently grown its market share and earnings since the recession of
2008. Consumers remain tight fisted and we do not anticipate these habits
to change anytime soon. We believe Dollarama will continue to thrive in
this environment and is well positioned to weather a further possible
slowdown in the economy; and

Dollarama’s balance sheet has continued to strengthen since the IPO and
we expect the company to distribute excess cash to shareholders in the
form of dividend increases and share buybacks over the next several
years. Dollarama’s current productivity initiatives remain on schedule and
we anticipate the company will generate cost savings of more than $15
million in the form of reduced labour costs and efficiency gains, with the
majority of benefits being realized in F2014 and F2015.
SEPTEMBER 19, 2012
Room for at least
468 additional
dollar stores
Multiple price point
strategy will continue
to boost SSSG
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DOLLARAMA INC.
Investors looking to hold Dollarama in the long term should consider the
following:

Dollar Tree’s merchandise mix, value proposition and strong financial
position present Dollarama with its first formidable competitor in the
Canadian dollar store space. We estimate approximately 10% of
Dollarama locations are currently located in close proximity to Dollar
Tree stores. However, the impact on Dollarama will only materialize
once Dollar Tree has significantly expanded its footprint, particularly in
Dollarama’s key markets of Ontario and Quebec, which we believe
will take two to three more years;

We believe gross margin expansion is limited at Dollarama and will
settle at current levels of 36% to 37% (42% to 43% before occupancy
costs). Although we anticipate Dollarama will continue to refine its
sourcing capabilities through enhanced operating leverage and
scale, the company will need to offset mounting inflationary pressures
and increasing transportation costs in order to maintain its gross
margin. In the event Dollarama cannot contain cost pressures, the
company may be forced to choose between increasing prices and
squeezing margins, particularly after F2015, when benefits from
current productivity initiatives are exhausted; and

Dollarama’s strong SSSG of 6% to 8% has been supported by the
introduction of items priced above $1.00 since Feb 2009, while the
traffic comps averaged 1.5% in the last 18 quarters. The strong traffic
comps in the last three quarters were largely due to weak year-overyear comparisons (-0.7% in Q4-F2011, -2.8% in Q1-F2012 and -0.5% in
Q2-F2012). Products priced above $1.00 reached an all-time high of
56% of sales in Q2-F2013. Thus, we believe Dollarama’s SSSG will slow
as the multiple price point strategy tops out and will settle at 4% in
F2015 and onwards.
Traffic comps will likely
slow in Q4-F2013
Given the results of our proximity analysis and the introduction of items above
the $2.00 price point, we believe Dollarama should deliver strong results over
the next 12 to 18 months. We expect Q3-F2013 to be particularly impressive,
given the weak year over year traffic comparison. We have upgraded our
recommendation to BUY on Dollarama, and we derive an intrinsic value
estimate of $66.00, which implies 19x F2014 P/E or 12x F2014 EV/EBITDA.
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September 19, 2012
DOLLARAMA INC.
3
CHASING THE SAME LOCATIONS…
Dollarama plans to open a total of 900 to 1,000 stores in Canada, while Dollar
Tree sees potential for 1,000 locations. Investors have questioned whether the
Canadian market can handle these expansion goals. Dollarama has a
commanding lead over Dollar Tree in terms of its current footprint, with 735
stores across Canada compared to Dollar Tree’s 118, as of August 2012. Figure
1 summarizes the growth of the six largest dollar store chains in Canada since
2004.
Figure 1
Six Largest Dollar Store Chains in Canada, 2004 – 2012
Number of Stores
2004
2012
Change
CAGR
2004 - 2012
Format
Dollarama
331
704
373
10%
Corporate
Dollar Giant (Dollar Tree)
12
99
87
30%
Corporate
Everything for a Dollar
67
66
(1)
(0.2%)
Franchise
Buck or Two Plus!
334
52
(282)
(21%)
Franchise
Your Dollar Store with More
160
120
(40)
(4%)
Franchise
Great Canadian Dollar Store
140
109
(31)
(3%)
Franchise
Total
1,044
1,150
106
1%
Dollarama’s Market Share
32%
61%
DOL has grown
while smaller chains
have shrunk
Source: Company Reports, Veritas estimates.
Dollarama and Dollar Tree offer a superior shopping experience and a better
assortment of products compared to the other dollar store chains in Canada.
We have excluded the smaller dollar store players from our industry growth
projections, as they are not well-capitalized, have a small store network and
have failed to grow their footprint over the last eight years. In fact, we believe
the smaller dollar store chains may see their market share shrink even further
as Dollarama and Dollar Tree continue to grow.
We have cross referenced our database of Dollarama and Dollar Tree
locations with every FSA1 in Canada. Figure 2 shows the number of Dollarama
and Dollar Tree locations in all Canadian FSA’s, broken down into population
ranges. For the purpose of our forecasts, we assume Dollarama will decelerate
new store openings as they approach a total of 950 stores by the end of
F2016, which is the midpoint of their guidance.
1
We define proximity based on Forward Sortation Area (“FSA”), the first three characters of a
Canadian postal code. Stores located within the same FSA are considered to be in proximity.
SEPTEMBER 19, 2012
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DOLLARAMA INC.
Figure 2
Dollarama and Dollar Tree Store Allocation by Population Range as of August 2012
# of
Dollarama
and Dollar
Tree
Locations
Total
Number of
FSA in
Canada
Dollarama
& Dollar
Tree FSA
Penetration
# of
Dollarama
Locations
% of
Store
Base
# of
Dollar
Tree
Locations
% of
Store
Base
<1,000
5
1%
1
1%
6
67
9%
1,000-10,000
64
9%
5
4%
69
399
17%
10,000-20,000
185
25%
21
18%
206
459
45%
20,000-30,000
218
30%
30
25%
248
333
74%
30,000-40,000
121
16%
35
30%
156
196
80%
40,000-50,000
72
10%
15
13%
87
85
102%
50,000-60,000
39
5%
5
4%
44
47
94%
60,000-70,000
11
1%
1
1%
12
17
71%
70,000-80,000
7
1%
0
0%
7
6
117%
80,000-90,000
5
1%
3
3%
8
8
100%
FSA by Population in
Canada
90,000-100,000
6
1%
2
2%
8
4
200%
100,000+
2
0%
0
0%
2
2
100%
Total
735
100%
118
100%
853
1,623
53%
<1,000 - 10,000
69
9%
6
5%
75
466
16%
10,000 - 100,000+
666
91%
112
95%
778
1,157
67%
20,000 - 100,000+
481
65%
91
77%
572
698
82%
Source: Veritas estimates.
Over 90% of Dollarama and Dollar Tree locations are in FSA’s with a population
greater than 10,000. FSA’s with populations less than 10,000 remain relatively
underpenetrated, as both dollar stores have only opened 75 locations out of
a possible 466, or a 16% penetration rate. We believe FSA’s where the
population is less than 10,000 will see tepid growth from the dollar store chains,
as the population density is insufficient to drive enough traffic for stores to be
sufficiently profitable.
Dollarama has stated it actively seeks to open stores in the same
neighbourhood or mall as Walmart stores, as it helps draw traffic from mass
merchant shoppers. We have included the store location data for Walmart
and cross referenced this with our dollar store database. The results can be
seen in Figure 3.
Figure 3
Proximity to Walmart and Average Population Density per Store
DOL and DLTR are
both anchoring to
WMT stores
# of Stores in
Proximity to Walmart
Total #
of
Stores
% of Store
Base
Average Population
of
FSA Per Store
Dollarama
311
735
42%
26,436
Dollar Tree
69
118
58%
30,562
Total
380
853
45%
27,039
Source: Veritas estimates.
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September 19, 2012
DOLLARAMA INC.
5
Both dollar store chains are clearly chasing after Walmart locations, with
roughly 45% of all Dollarama and Dollar Tree locations in proximity to a
Walmart store. As of August 2012, only 75 FSA’s currently remain with a
Walmart location and no dollar store presence. Dollarama has an average
population per store ratio of 26,436, while Dollar Tree’s population per store
ratio is higher at 30,562, further evidence that the dollar store operators are
focused on expanding in areas where the population is greater than 20,000.
Although many dollar store locations are currently in proximity to Zellers stores,
we believe the increase in consumer traffic and the associated uptick in sales
for dollar stores will be much greater when the Zellers stores are converted to
Target locations. Of the 134 locations Target plans to open between 2013 and
2014, we estimate there are 16 FSA’s for which there is no current dollar store
presence. Combined with Walmart, this presents 91 locations for Dollarama
and Dollar Tree to open new stores in proximity to mass merchants as of
August 2012. However, we expect store growth from Walmart and Target to
slow significantly in 2015 and onwards, leaving Dollarama and Dollar Tree
fewer big box stores to anchor to.
Although we do not expect any significant growth from the remaining dollar
store players in Canada, we believe their current footprint will limit expansion
opportunities in certain provinces, particularly in Eastern Canada. Figure 4
shows the number of locations operated by the six largest dollar store
companies, broken down by region. We have also included the current
population per store for all dollar store locations within each region, as well as
Dollarama’s share of its own growth in these areas over the past three years.
Figure 4
Current Dollar Store Penetration by Region as of August 2012
Number of
Dollarama
Locations
Number of
Competitor
Locations
Dollarama
Market
Share
Population
Per Store
Share of Dollarama
Growth
(Aug 2009 – Aug 2012)
Western Canada
133
233
36%
28,106
29%
Ontario
300
127
70%
30,098
48%
Quebec
234
2
99%
33,487
18%
Eastern Canada
68
80
46%
15,727
5%
Total
735
442
62%
28,351
100%
Region
Eastern
Canada offers
fewer growth
opportunities
Source: Company Reports, Statistics Canada, Veritas estimates.
The data shows the Eastern Canadian provinces are the least likely to see
expansion from Dollarama. The population per store for the region is roughly
half that of the remaining areas in Canada and Dollarama’s growth in the
region has been minimal over the past three years, despite having a market
share of only 46%. However, we do not believe the Canadian market can
support a national average of 16,000 people per dollar store without risking a
significant decrease in average store volumes. For example, Quebec would
appear as the most attractive region for expansion, as it has the highest
population per store ratio in Canada, yet Dollarama’s share of total growth in
the Quebec region over the past three years has only been 18%, well behind
Western Canada and Ontario. We believe Dollarama has reduced growth in
Quebec due to its dominant market share (over 99%), as the resulting
cannibalization does not justify the addition of new stores. Also, the average
SEPTEMBER 19, 2012
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DOLLARAMA INC.
population per FSA in Eastern Canada is less than 50% of the average of
Western Canada, Quebec and Ontario, which biases the population per store
figure downward significantly.
To assess the viability of Dollarama and Dollar Tree’s long term expansion
goals, we have identified the number of FSA’s with a population greater than
10,000 and no current dollar store presence. We believe these locations are
consistent with the new store criteria specified by Dollarama, as it addresses
population, traffic, competitor presence and Dollarama’s current footprint.
These locations include roughly 90% of the 91 FSA’s where there is a Walmart
location and to-be converted Target store with no current Dollarama or Dollar
Tree. The results of this analysis can be seen in Figure 5.
Figure 5
Number of Optimal Dollar Store Locations Remaining in Canada
FSA Population
# of FSA with zero
Dollarama Stores
# of FSA with zero
Dollar Tree stores
# of FSA with zero
dollar stores
(all chains)
Total Number of
FSAs
<1,000
62
66
61
67
1,000-10,000
337
394
293
399
10,000-20,000
288
438
238
459
20,000-30,000
160
306
123
333
30,000-40,000
100
165
70
196
40,000-50,000
32
75
19
85
50,000-60,000
20
42
9
47
60,000-70,000
9
16
4
17
70,000-80,000
3
6
2
6
80,000-90,000
3
6
1
8
90,000-100,000
1
3
1
4
100,000+
1
2
1
2
> 10,000
617
1059
468
1,157
Western Canada
142
Ontario
160
Quebec
144
Eastern Canada
19
Territories
3
Canada
468
Source: Veritas estimates.
We consider these locations to be optimal in regards to Dollarama and Dollar
Tree’s current growth plans and we anticipate the retailers will compete
aggressively for them. We do note that there are several FSA’s where
Dollarama and Dollar Tree both have locations – in some cases, multiple
locations – however, the majority of these FSA’s have populations greater
than 20,000. As seen above in Figure 2, FSA’s with populations above 20,000
are already penetrated at more than 80%, and thus new locations in these
areas are more likely to face competitive pressures and lower-than-average
volumes. We believe multiple stores within the same FSA can still be profitable,
but investors must be cognizant of the impact of cannibalization on
Dollarama’s long term SSSG. Based on our analysis of vacant FSA’s with
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September 19, 2012
DOLLARAMA INC.
7
populations greater than 10,000, we believe there is room for an additional
468 dollar stores in Canada before the market becomes saturated and
cannibalization begins to have a material impact on new store openings.
On their latest conference calls, Dollarama and Dollar Tree announced they
will surpass their original guidance for new store openings in F2013. Dollarama
now expects to open 65 to 70 new locations (previously 50 to 60) while Dollar
Tree anticipates it will open 35 to 37 new stores (previously 25). Both retailers
explained the increase in new store growth is due to more opportunities
available in the real estate market as a result of increased construction
activity, particularly around malls and mass merchant locations.
If we assume both retailers will expand at a rate of roughly 60 stores each per
year, it will take roughly four more years before the number of optimal
locations runs out. We do note this assumes the retailers will not expand in
existing markets, which is unlikely given the current overlap of Dollarama and
Dollar Tree locations. As a result, growth will likely continue beyond F2017,
albeit at a much slower rate in a more saturated market. Our store growth
projections for Dollarama and Dollar Tree are shown in Figure 6.
Figure 6
Dollarama and Dollar Tree Store Growth Projections
End of Fiscal Year
Dollarama
F2012
F2013E
F2014E
F2015E
F2016E
F2017E
704
772
832
892
952
978
68
60
60
60
26
136
196
256
316
342
37
60
60
60
26
413
293
173
53
0
Y-o-Y Change
Dollar Tree
99
Y-o-Y Change
Number of Optimal
Locations Remaining
-
Canadian market
can support four
years of aggressive
growth
Source: Veritas estimates.
Dollarama’s commanding market share lead over Dollar Tree will position it
well to take advantage of the best real estate opportunities over the next
several years, focusing on the optimal locations we have identified in our
proximity analysis. Dollar Tree will be forced to expand into less desirable areas
after Dollarama approaches a network of 1,000 stores, or run the risk of
expanding into regions with an existing dollar store presence and more
competitive pressure.
We note our assumption of 120 new stores per year may be aggressive given
Dollar Tree will open less than 40 stores in the current fiscal year, but we
anticipate the U.S. retailer will accelerate store openings after F2013. In light of
the results of our proximity analysis and growth projections, we conclude that
Dollarama’s goal of expanding to 900 to 1000 stores from its current store base
of 735 is realistic, while Dollar Tree’s goal of reaching 1,000 stores from its
current footprint of 118 is wishful thinking.
Given Dollarama successfully opened 52 stores in F2012 and plans to open 65
to 70 in F2013, we are not anticipating any major logistical issues for the retailer
in their pursuit of opening 60 stores per year going forward. However, our
forecast assumes the real estate market will be able to meet demand from
Dollarama and Dollar Tree, which may not be the case as the companies
continue to grow their network and 10,000 square feet locations meeting their
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DOLLARAMA INC.
criteria dwindle in supply. This could lead to bidding wars for prime locations
and a subsequent increase in rent expense. In fact, Dollarama management
indicated they have already begun to experience an impact on rent
expense, as Dollar Tree’s expansion is increasing demand for new locations,
which has given landlords significant bargaining power. As a result, we have
forecasted rent expense to increase at an annual rate of 3.5% to 4.0% from
F2013 onwards.
Many have drawn on the U.S. dollar store industry to justify the generous room
for expansion of the dollar store industry in Canada. According to Dollarama’s
2012 AIF, as of January 29, 2012, the top five U.S. dollar store chains served
approximately 14,000 people per store, while the top six Canadian dollar store
chains served roughly 30,000 people per store. This would imply the Canadian
market has room for more than 2,400 dollar store locations. However, as we
outlined in our initiating coverage report, this statement is misleading as only a
portion of U.S. dollar stores are comparable to Dollarama’s operating model.
Figure 7 summarizes the four largest dollar stores in the U.S.
Figure 7
Summary of U.S. Dollar Store Chains
F2012
Dollarama
Dollar
Tree
Dollar
General
Family
Dollar
99 Cents
Only
Price Range
Up to $3.00
US$1.00 in U.S,
$1.25 in Canada
Up to US$10.00
Up to US$10.00
Up to US$0.99
No. of Stores
704
4,351
9,961
7,023
298
Store Size (selling sq.ft.)
9,905
8,640
7,200
7,100
21,000
Consumables
37%
51%
73%
67%
65%
General Merchandise
49%
45%
13%
22%
31%
Seasonal
14%
5%
14%
11%
4%
Source: Veritas estimates.
The two largest dollar store operators in the U.S. – Dollar General and Family
Dollar – both offer products up to US$10.00, with consumables representing
approximately 70% of the product mix. This is in direct contrast to Dollarama,
which offers items up to the $3.00 price point and consumable products
represent less than 40% of its product offering (based on retail value).
Consumables play a key role for dollar store chains in the U.S., as retailers must
meet the following criteria in order to accept food stamps as a method of
payment, as per the Supplemental Nutrition Assistance Program (“SNAP”) in
the U.S.:

Retailers can obtain a permit if they sell a variety of staple foods in
each of four food categories: (1) dairy products (2) breads, grains,
and cereals (3) fruits and vegetables and (4) meat, fish, and poultry.
Foods can be fresh, frozen, or canned. However, retailers must stock
perishable foods in at least two of the food categories.

Alternatively, retailers can obtain a permit if more than 50% of gross
retail sales come from the sale of one or more staple foods.
Note: Staple foods do not include coffee, tea, candy, soft drinks, snack
foods, or certain other ready-to-eat items.
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September 19, 2012
DOLLARAMA INC.
In June 2012, there were over 46 million participants enrolled in the SNAP. This is
the highest participation level since the programs inception in 1969 and the
fifth consecutive year of growth. SNAP enrolment has supported strong growth
from dollar store operators such as Dollar General and Family Dollar. If these
dollar store chains were not able to obtain permits to accept food stamps, we
believe the market for dollar store chains would shrink significantly in the U.S.
9
SNAP participants
are greater than the
entire population of
Canada!
The most comparable dollar store chain to Dollarama in the U.S. is Dollar Tree,
followed by 99 Cents Only. If we only include these two chains, U.S. dollar store
chains serve approximately 67,000 people per store. This estimate assumes
Dollarama and operators like Family Dollar and Dollar General fall into
mutually exclusive categories, which is also misleading. Thus, we estimate the
comparable number lies in the middle of 14,000 and 67,000. However, we do
not believe the U.S. market is comparable to Canada, given the stark contrast
between dollar store operators and economic trends.
We believe the best measure of the growth opportunity in the Canadian
market is derived from our proximity analysis, which shows the market can
comfortably handle at least 468 additional Dollarama and Dollar Tree
locations. Combining the current market share of the remaining dollar store
players in Canada, our proximity analysis suggests Canada can support a
minimum of 1,647 total dollar store locations, compared to the current 1,179
dollar store locations.
A LOONIE AT DOLLARAMA STILL GOES A LONG WAY…
The introduction of a multiple price point strategy at Dollarama was
interpreted by many as a means for the company to maintain (or even grow)
margins through price increases, thereby shielding Dollarama from inflationary
pressures and higher expenses. The fear was that Dollarama’s value
proposition would be damaged, and customers would respond by shopping
elsewhere for products they felt increased in price, or became too expensive.
In August 2010, we conducted a price survey at Dollarama and Walmart
where we compared the prices of 45 general merchandise products and
concluded the following:

Of the 45 items in the basket, 55% were priced lower at Dollarama
compared to Walmart, 14% were priced higher and 31% were priced
at parity;

Excluding three outliers, Dollarama prices were on average 16% lower
than Walmart; and

Of the items that were priced lower than Walmart, Dollarama prices
were on average 33% lower.
We conducted the same price survey in August 2012 to gauge how prices
have changed at both stores. We also included Dollar Giant in the August
2012 survey to see how Dollarama stacks up against its biggest and most
comparable competitor, which we will discuss later on in this report. For the
August 2012 survey, we concluded the following:

Of the 45 items in the basket, 84% were priced lower at Dollarama
compared to Walmart, 11% were priced higher and 4% were priced
at parity;

Dollarama prices were on average 35% lower than Walmart; and
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DOLLARAMA INC.

Of the items that were priced lower than Walmart, Dollarama prices
were on average 40% lower.
Over the past two years, as Dollarama has consistently increased its
penetration of sales of items above $1.00, it also significantly widened its
pricing gap with Walmart, from 16% to 35%. However, we cannot give all the
credit to Dollarama, as the primary reason for the price disparity was due to
large prices increases at Walmart, as seen in Figure 8.
Figure 8
Price change August 2010 – August 2012
DOL prices flat,
WMT up 13%
Average Price per Item
Aug-10
Aug-12
Price Change
Dollarama
$1.041
$1.042
0.2%
Walmart
$1.427
$1.607
12.6%
Source: Veritas estimates.
There are few, if any, retailers who would sit back and watch Walmart
increase prices while leaving their own prices untouched. In fact, of the 45
items in our basket, the prices for 37 of the items at Dollarama were the same
in August 2012 as they were in August 2010. However, we believe Dollarama’s
competitive response was deliberate in nature; regardless of whether Walmart
increases prices or not, Dollarama is committed to providing the best value at
every price point. The introduction of multiple price points at Dollarama has
not resulted in price increases for lower priced items; rather, it has allowed
Dollarama to expand its product catalogue and offer more products at
industry leading price points.
Dollarama began offering a select number of items at the $2.50 and $3.00
price points in July 2012. Management explained this decision was in response
to consumer demand for additional products that cannot currently be offered
below $2.00. In light of the results of our price survey, we believe the new price
points are not being introduced to disguise price increases on existing
products. We anticipate Dollarama will absorb cost increases at the expense
of margins or through clever re-packaging, rather than damaging their value
proposition with higher prices. Clever re-packaging refers to offering the same
product at the same price while slightly decreasing the quantity or size, in
order to maintain gross margin without attracting significant attention from
customers.
Management reiterated that its goal is to maintain its gross profit margin of
36% to 37% (42% to 43% before occupancy costs) in the long term. Given the
company reported an average gross profit margin of 36.60% (42.70% before
occupancy costs) over the last ten quarters, we believe Dollarama’s margins
have already peaked, as seen in Figure 9.
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September 19, 2012
DOLLARAMA INC.
11
Figure 9
Gross Profit Margin Before and After Occupancy Costs, Q1-F2011 to Q2-F2013
(Amounts in millions of Canadian dollars)
Q1-F11
Q2-F11
Q3-F11
Q4-F11
Q1-F12
Q2-F12
Q3-F12
Q4-F12E
Q1-F13
Q2-F13
Quarterly
02-May-10
01-Aug-10
31-Oct-10
30-Jan-11
01-May-11
31-Jul-11
30-Oct-11
29-Jan-12
29-Apr-12
29-Jul-12
Average
Sales
311.9
343.5
355.7
408.7
346.3
387.5
400.3
468.7
398.0
441.0
Gross Profit
127.8
141.8
149.8
178.5
147.2
165.2
172.0
211.3
170.3
189.1
GPM
40.96%
41.29%
42.12%
43.67%
42.51%
42.63%
42.96%
45.09%
42.78%
42.89%
Y-o-Y Change
0.73%
1.86%
1.43%
(0.96%)
1.55%
1.34%
0.84%
1.42%
0.27%
0.26%
20.8
20.7
21.2
22.3
23.5
23.0
23.9
24.9
25.8
26.6
Rent as % of Sale
6.65%
6.01%
5.96%
5.47%
6.78%
5.94%
5.97%
5.32%
6.49%
6.03%
GPM - Rent Margin
34.31%
35.27%
36.15%
38.20%
35.73%
36.68%
36.99%
39.77%
36.29%
36.85%
Y-o-Y Change
1.07%
0.55%
(2.97%)
2.86%
1.42%
1.41%
0.83%
1.57%
0.56%
0.17%
Rent Expense
42.69%
36.62%
Source: Company reports, Veritas estimates.
WHEN WILL PRICES REACH
THE TIPPING POINT?
Figure 10 shows that the strong SSSG of 6% to 8% has been supported by the
introduction of new merchandise above the $1.00 price point since February
2009, while the traffic comps averaged only 1.5% in the last 18 quarters.
Dollarama reported strong traffic comps of 3% to 4.5% in the last three
quarters, but this was primarily due to weak comparisons from the same
quarters last year. We believe Dollarama will report weaker traffic comps in
Q4-F2013 once the easy year-over-year comparisons have cycled. The
products that were above the $1.00 price point represented 56% of sales in
Q2-F2013, representing an all-time high for Dollarama.
Figure 10
Quarterly Same Store Sales Growth Breakdown, Q1-F2010 to Q2-F2013
Q1F10
Q2F10
Q3F10
Q4F10
Q1F11
Q2F11
Q3F11
Q4F11
Q1F11
Q2F11
Q3F11
Q4F11
Q1F12
Q2F12
Q3F12
Q4F12
Q1F13
Q2F13
Increase in No. of
Transactions
(Traffic)
3.5%
1.4%
1.1%
3.3%
1.9%
1.4%
1.6%
(0.7%)
1.9%
1.4%
1.6%
(0.7%)
(2.8%)
(0.5%)
(0.1%)
4.0%
4.5%
2.7%
Increase in
Average
Transaction Size
4.0%
5.6%
6.2%
5.8%
6.6%
6.2%
6.3%
6.1%
6.6%
6.2%
6.3%
6.1%
6.3%
5.3%
5.2%
3.8%
3.5%
4.5%
Same Store Sales
Growth (SSSG)
7.5%
7.0%
7.3%
9.3%
8.6%
7.8%
7.9%
5.3%
8.6%
7.8%
7.9%
5.3%
3.4%
4.7%
5.1%
7.9%
8.1%
7.3%
% of Sales from
Units >$1
12%
24%
27%
30%
34%
39%
40%
42%
34%
39%
40%
42%
44%
48%
49%
50%
51%
56%
Source: Company reports
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DOLLARAMA INC.
With the $2.50 and $3.00 products now available in Dollarama stores, one may
wonder when Dollarama will cap its multiple price point strategy. Is $3.00 the
magic number? $4.00? $5.00? Alas, one could speculate and justify any
number of prices. However, we believe it is more important to focus on what
happens to existing prices when higher price points are introduced. As long as
Dollarama remains competitive with Dollar Tree (and, to a lesser extent,
Walmart) for items at the $1.00 to $1.25 price range, we believe additional
products at higher price points will be a positive catalyst for the company.
Many would argue items priced above the $2.00 price point will tarnish
Dollarama’s image as a value retailer, but given the results of our price survey,
we believe Dollarama will introduce higher price point items in direct response
to consumer demand, while maintaining its core offering of $1.00 products.
Value proposition
expanding to include
higher priced items
We visited two Dollarama locations in the Greater Toronto Area to observe the
mix and placement of products at the recently introduced $2.50 to $3.00 price
points. Please see Appendix A for pictures taken during our visit to Dollarama
stores. Many of these products are distinct from Dollarama’s typical offering;
RCA universal remotes, step stools and Snuggie blankets, to name a few.
Several of these items retail for nearly double the price at competing
locations. For example, “Snuggie for Kids” retails at US$14.99 (currently on sale
for US$8.17) on Amazon.com, while a similar RCA remote on Walmart.com
retails for US$7.88. Considering Amazon and Walmart are two of the most
prominent and influential price leaders in the market (also note the prices
above are based on Walmart and Target’s U.S. websites, which are generally
cheaper than their Canadian equivalents) Dollarama’s prices are simply
unbeatable. Even if Walmart and Amazon slashed their prices in half,
shopping at Dollarama for both items would still save consumers roughly $5.40,
or 90%.
Dollarama is choosing the most prominent and visible shelf space in the store
to showcase its new items above $2.00, with the majority of merchandise
found at the front and back of every aisle. Placing these new products in the
store’s most lucrative shelf space is a clear sign Dollarama is committed to the
pricing strategy above the $2.00 price point. Our discussions with Dollarama
employees lead us to believe these items are selling very well, perhaps even
better than anticipated. We believe the image of Dollarama as a value
retailer has been enhanced with the introduction of the new products above
the $2.00 price point and this will translate to an increase in average basket
size, which should boost SSSG over the next two years, with a more significant
impact in F2014. We do note the majority of merchandise we observed was
priced at $3.00, with far fewer items at $2.50.
Given the nature of these new products and discussions with industry experts,
we believe Dollarama may be sourcing a portion of the higher priced items
from liquidation sales. Also, during our visit to both Dollarama locations, we
observed significantly less product overlap in the $2.50 to $3.00 price range
when compared with items in the $1.00 price range, which suggests some of
these higher priced items are being purchased opportunistically and not
necessarily across the entire store network. On the latest conference call,
management indicated that many of the higher priced items are deal driven
and will not be available throughout the year, consistent with our observation.
Although items above the $2.00 price point were only introduced in July 2012,
if Dollarama is sourcing a significant number of these products through
liquidation sales, we believe it will improve profitability for the retailer. Reason
being, closeout merchandise is typically sold at steep discounts which allows a
healthy gross margin to be earned. The majority of Canadian closeout retailers
offer products that can cost up to $50.00 and focus on categories such as
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September 19, 2012
DOLLARAMA INC.
13
clothing, furniture and hardware, which is significantly different from
Dollarama’s current product mix and pricing strategy. Given the lack of
Canadian competitors that offer liquidation items below the $5.00 price point,
Dollarama will be in a dominant position to corner the closeout merchandise
market and leverage its purchasing power. Although Dollar Tree does
purchase promotional inventory (roughly 10% of its offering), its $1.25 single
price point strategy will limit its ability to compete with Dollarama for the
majority of closeout merchandise available.
We believe it would be premature to model the impact of liquidation
merchandise on Dollarama’s gross margin at this time, as our observation is
speculative and the items have only been offered for a very short period of
time. Dollarama informed investors that the new items in the $2.50 to $3.00
range did not have a material impact on its latest quarterly results, as they
were only offered for two weeks of Q2-F2013.
Management indicated that fewer items are being offered from suppliers in
China and neighbouring countries with compelling value at the $1.00 price
point, as inflationary pressures have limited the pool of products available at
lower prices. Given Dollarama refreshes roughly 25% of its offering annually,
we expect the percentage of items priced at $1.00 to consistently decline as
the company continues to expand. This will help drive SSSG through higher
average transaction size, as it has done in the past.
SEPTEMBER 19, 2012
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DOLLARAMA INC.
WHAT DO CUSTOMERS THINK?
In our initiating coverage report in September 2010, we conducted 400
consumer surveys at 8 Dollarama stores across the GTA. In August 2012, we
conducted the same survey at four Dollarama stores and collected 100
responses. The results from both surveys are depicted in Figure 11 and the
questionnaire used can be seen in Appendix B.
Figure 11
Dollarama Customer Survey Results, September 2010 – August 2012
Survey Results
Sep-10
Questions
Age
Income level
Purpose
Survey Results
Aug-12
<29
30-49
>50
<29
30-49
>50
26%
43%
32%
48%
28%
24%
<$40,000
$40-$60,000
$60,000+
<$40,000
$40-$60,000
$60,000+
50%
37%
13%
43%
22%
35%
Food
Household
GM
Food
Household
GM
24%
12%
64%
6%
16%
78%
Number of Items
Bought
6.6
Dollars spent
<$5
$5-$10
$10+
<$5
$5-$10
$10+
37%
33%
30%
24%
28%
48%
Yes
No
Yes
No
83%
17%
64%
36%
Yes
No
Yes
No
57%
43%
68%
32%
Yes
No
Yes
No
85%
15%
72%
28%
Rarely
Once
2-5 times
Rarely
Once
2-5 times
15%
34%
52%
20%
28%
52%
Yes
No
Yes
No
56%
44%
44%
56%
25 cents
50 cents
$1
25 cents
50 cents
18%
41%
40%
20%
20%
60%
Dollarama
Walmart
Zellers /
No Frills
Dollarama
Walmart
Zellers /
No Frills
55%
41%
4%
67%
28%
5%
Prices have Risen
Plan Visit to
Dollarama
Plan Visit to
Walmart
Trip Frequency
(per month)
Compare prices to
Walmart
Sensitive to Price
Increase
Best Value
8.9
$1
Source: Veritas estimates.
In the August 2012 section, the green cells refer to responses which have
shown an improvement since the original survey in September 2010, while the
red cells refer to portions of the survey that had worse results in August 2012.
We do note that the results of these surveys are subject to sample error as well
as sample bias, given the size of our samples and geographical limitations of
the store locations. Nonetheless, we believe the results in August 2012 are
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September 19, 2012
DOLLARAMA INC.
15
consistent with Dollarama’s performance over the last two years and offer
valuable insight into how customer perceptions have changed.
In September 2010, customers purchased an average of 6.6 items and only
30% of respondents spent over $10. Two years later, the average number of
items has climbed to 8.9, while nearly half of the respondents spent more than
$10. We believe this is a direct result of Dollarama’s multiple price point
strategy, as well as the introduction of their debit payment system. We
anticipate average basket size will continue to increase as Dollarama
introduces more items at the $2.50 and $3.00 price points.
Average basket size
continues to climb
When asked whether prices have increased over the past year, in August
2012, 64% of customers responded yes. Our price survey revealed that prices
for items in the $1.00 range at Dollarama have been flat over the past two
years. Thus, we believe customers are mistakenly interpreting the addition of
higher price point items as overall price increases for all products. Fortunately
for Dollarama, the 64% of respondents that believed prices have increased in
August 2012 is significantly down from 83% in September 2010. This suggests
some customers are recognizing that the addition of higher priced items does
not actually mean prices have increased at Dollarama. Dollarama is aware of
this misinterpretation and is taking steps to remind customers, as seen in Figure
12.
Figure 12
Sign in the Entrance of a Dollarama store in Thornhill, Ontario
Source: Veritas
Given the results of our price survey above, it would be beneficial for
Dollarama customers to compare prices with Walmart more often, as they
would discover the significant price premiums at Walmart stores. However, our
August 2012 customer survey showed only 44% of consumers compared prices
with Walmart, compared to 56% in September 2010. Given Dollarama does
not spend a significant amount on marketing, price discovery through
consumer experience is one of the most efficient ways for Dollarama to
demonstrate its value proposition. If the trend of less price comparing
continues, we believe more customers will blindly commit to believing in
SEPTEMBER 19, 2012
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DOLLARAMA INC.
Walmart’s “Every Day Low Pricing” motto and, as a result, bypass their visit to
Dollarama.
Dollarama thrives on its value proposition and we believe it must maintain this
image in order for the company to succeed in the long term. In August 2012,
67% of respondents believed Dollarama offered the best value when
compared with Walmart, Zellers and No Frills, while only 55% of respondents
had the same perspective in September 2010. We do note Dollar Tree was not
included in the choices for this question, but given its insignificant presence in
Ontario, we do not believe it would have had a material impact on the survey
results. Despite Walmart’s aggressive expansion and introduction of its dollar
days program, we believe Dollarama is holding its ground as Canada’s top
value retailer.
A GROWTH STOCK WITH A DEFENSIVE ATTITUDE…
DOL consistently
posts the strongest
comps in the
Canadian retail
universe
A weak economic backdrop generally spells bad news for retailers, as
consumers spend less, save more and trade down their spending habits.
Although Dollarama is not immune to a slowdown in the general economy,
we believe it is better positioned than any other retailer in Canada to weather
the storm, and perhaps even benefit from it. Whether or not the economy
takes a nosedive in the near future is unknown (that is, until Mr. Draghi or Mr.
Bernanke deliver their next speech…), but the fragile state it is currently in
cannot be overlooked.
Since the great recession of 2008, Canadian consumers have remained tight
fisted, and retailers have scrambled to keep up with the secular change in
spending habits. The state of the Canadian grocery industry is evidence of this
trend, as discount banner expansion continues to outpace conventional
openings and promotional activity remains fierce, particularly in Ontario.
Clothing retailers have also felt the pinch and responded with aggressive
promotional activities.
In January 2012, Walmart launched a tool that tracks the financial health of
Canadian households on a monthly basis, called the Walmart Canada
Income Tracker. The tracker compares average household income with key
financial obligations and estimates spending power2 based on the money
available after obligations are met. The Walmart Income Tracker is developed
by Fusion Retail Analytics, a consumer insight firm, and is based primarily on
data released by Statistics Canada as well as proprietary Fusion Retail
Analytics data sources. During the first half of 2011, Walmart reported
Canadian households saw incomes grow at a faster rate than financial
obligations compared to the same period in 2010. However, this trend
reversed in July 2011, as key household expenses began to rise faster than
income. The erosion in spending power was mainly attributable to increasing
transportation, food and utility costs.
The latest Income Tracker report, released on April 30th, revealed spending
power declined by $3 in March 2012 versus March 2011, marking the 9th
consecutive month of spending power erosion. Although household income
increased in February and March, it was more than offset by higher food,
shelter and transportation costs. Fortunately for Dollarama, none of these
expense categories are part of their core offering, which should help
2
v
Spending power is defined as the money available to spend on discretionary items or
experiences, after key financial obligations (i.e. costs associated with shelter, transportation,
utilities and food) are met.
September 19, 2012
DOLLARAMA INC.
17
Dollarama’s image as a value retailer stand out as consumers continue to
face higher grocery and gas bills, given the recent surge in commodity prices.
In Figure 13, we have plotted the Income Tracker data along with Dollarama’s
SSSG. Although the data set only spans two years, it does show the resiliency
of Dollarama’s business despite a shrinking consumer wallet.
Figure 13
12.0%
$125
10.0%
$100
8.0%
$75
6.0%
$50
4.0%
$25
2.0%
$0
0.0%
Mar-12
Jan-12
Feb-12
Dec-11
Oct-11
Nov-11
Sep-11
Jul-11
Aug-11
Jun-11
May-11
Apr-11
Mar-11
Feb-11
Jan-11
Dec-10
Nov-10
Oct-10
Sep-10
Aug-10
-6.0%
Jul-10
-$75
Jun-10
-4.0%
Apr-10
-$50
May-10
-2.0%
Mar-10
-$25
Dollarama SSSG
$150
Feb-10
Spending Power (Canadian Dollars)
Canadian Spending Power versus Dollarama SSSG
Source: Walmart Canada, Company Reports.
We believe consumers will remain tight fisted and value oriented until the
economy has shown substantial and sustainable improvement. In other words,
the likelihood of consumers trading up versus down is slim to nil in the near
term. Old habits are indeed hard to break. Consumers will continue to seek
value and retailers will continue to fight for a share of their wallet. While the
majority of Canadian retailers will continue to compete aggressively on price
and promotional activity, Dollarama has far less to worry about given their
rock bottom prices and lack of price increases over the past two years. We
believe consumers will turn to Dollarama as a means to reduce their spending
and get more ‘bang for the buck.’
Consumers remain
tight fisted and
continue to seek value
ADD MILK TO THE DOLLARAMA SHOPPING LIST?
When store openings begin to slow and competition ramps up, one may
wonder what else Dollarama can do to maintain their stellar record of top line
and bottom line growth. We believe gross margin expansion is limited, as the
company has indicated margins will settle at current levels in the long term
and Dollarama continues to roll out higher price point items, which the
company claims have lower profitability compared to products in the $1.00
price range.
We believe Dollarama may adopt one or both of the following strategies in
order to drive growth once new store openings slow and benefits from
productivity efficiencies begin to lap. First, we anticipate Dollarama will
continue to expand its multiple price point strategy in order to increase
average transaction size and broaden its product offering over the next
several years, as discussed earlier in this report. The second potential strategy
Dollarama may pursue is the introduction of refrigerated consumables and
frozen products. This would allow Dollarama to carry more staple items, such
SEPTEMBER 19, 2012
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DOLLARAMA INC.
as milk and eggs. The introduction of these products will be a drag on margins,
given the lower profitability of consumables, but we believe this will be more
than offset by an increase in traffic as Dollarama will capture more ‘top-up’
shopping trips.
However, Dollarama management indicated on its Q1-F2013 conference call
that it will not rely on consumables and national branded products to drive
traffic in order to have better control over its gross margin. This is interesting
given U.S. dollar stores typically use food and national branded products to
drive traffic. Dollar Tree currently has freezers and coolers in 53% of its stores
and Dollar Tree’s management indicated that the installation of freezers and
coolers can lift SSSG by 5% to 10%. This is probably one of the reasons that
Dollar Tree has consistently reported strong traffic comps, despite the fact that
it only operates under a single price point model. Although we do not
anticipate Dollarama will expand into refrigerated consumables in the near
term, we view the expansion into refrigerated consumables as a potential
long term opportunity for Dollarama.
PRODUCTIVITY INITIATIVES ON TRACK
Labour costs
associated with
manual inventory
counting will decrease
significantly
Dollarama currently has a number of initiatives underway which should help
reduce SG&A while increasing productivity at stores. The company installed
POS scanners in January 2011 and began using scan data as the primary
source of information for store replenishment purposes in July 2012. Although
scanning technology helps reduce shrink by increasing pricing accuracy and
reducing cashier error, the primary benefit for Dollarama will stem from the
labour cost savings associated with physical inventory counting. However, we
believe Dollarama will continue physically counting inventory in parallel to the
POS system for the remainder of F2013. Thus, we expect modest expense
savings in F2013, with the majority of benefits realized in F2014 and F2015. As
Dollarama expands its product offering and multiple price point strategy, the
POS system will be a key tool in optimizing purchase decisions and tracking
the profitability of new items. We believe Dollarama will generate labour
savings in excess of $15 million over the next two to three years as a result of
the POS implementation.
The initial roll out of the Kronos system was completed during Q2-F2013, with
the second phase to be completed by the end of F2013. The Kronos system
replaces employee time sheets with biometric boxes which are directly linked
to the payroll system. The initial roll out of the Kronos system will be used
primarily to gather data, whereas the second phase will serve as a work
management system to help improve employee scheduling. Dollarama will
realize the majority of cost savings from the second phase of the Kronos
initiative, beginning in F2014 and through F2015. We believe the system will
help enhance store productivity and reduce employee absenteeism, which
should help offset minimum wage pressure on SG&A.
Dollarama has also focused on improving supply chain management through
the automation of its distribution center as well as an improved warehouse
management system. The second phase of Dollarama’s automated
distribution center has been rolled out and the company expects the majority
of benefits to be realized in F2014 in the form of labour productivity gains. The
company successfully implemented its new warehouse management system
at all four of its warehouses during the summer of 2012. We expect the new
system will help optimize and expand warehouse capacity by addressing the
placement of inventory, pallets and traffic flow. This initiative will result in
efficiency savings beginning in F2014 through F2015.
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September 19, 2012
DOLLARAMA INC.
19
INVENTORY TURNS LAGGING BEHIND
For most retailers, the introduction and implementation of POS systems has
been one of the most important investments in technology over the past
decade. Enter Dollarama, a company with over 700 stores in operation for 20
years, yet F2014 will be marked as the first year the company will utilize a POS
system for replenishment purposes in favour of manual inventory counting.
Indeed, Dollarama is well behind the curve when it comes to technology and
their balance sheet reflects the worst average inventory turnover ratio in the
industry over the past five years, as seen in Figure 16.
Figure 16
Inventory Turns for the Largest Dollar Stores Operators in North
America
F2008
F2009
F2010
F2011
F2012
Average
Dollar General
5.0x
5.2x
5.3x
5.2x
5.3x
5.2x
Family Dollar Stores
4.3x
4.4x
4.8x
5.0x
5.1x
4.7x
Dollar Tree
3.7x
3.8x
4.1x
4.2x
4.2x
4.0x
99 Cents Only Stores
3.2x
3.5x
3.5x
3.2x
3.0x
3.3x
Dollarama
2.9x
2.9x
3.0x
3.3x
3.2x
3.1x
Source: Company reports, Veritas estimates.
We have chosen to focus on comparing Dollarama and Dollar Tree, as the
other dollar stores have a higher percentage of quick-moving consumables
and different pricing strategies. Both companies use the retail inventory
method, which relies heavily on management assumptions. Additional detail
on the retail inventory method can be found in Appendix D.
In 2001, Dollar Tree began installing POS systems in its stores and successfully
implemented the system by 2003. For the past five years, Dollar Tree has
consistently improved its inventory turnover ratio, from 2.9x in 2004, to 4.2x in
2011. However, in January 2010, Dollar Tree began using 30 distinct inventory
pools as opposed to a single pool in order to calculate its retail inventory. As a
result, the company recorded a one-time charge of $26.3 million to gross profit
and a corresponding reduction in inventory (at cost) in Q1-F2010. The
company decided to expand its number of inventory pools as the data
provided from its POS and merchandising systems allowed Dollar Tree to
distinguish products easily and more accurately.
POS
implementation
likely to improve
inventory turnover
for DOL
Dollarama sources 54% of its purchases from overseas vendors, the majority of
which is sourced from China. Dollarama’s supplier base is well diversified with
no single supplier representing more than 6% of its total purchases. Thus,
Dollarama has a complex and varied inventory pool and we believe the
assumption of a single inventory pool within the retail method results in
inaccurate estimates of inventory. Although Dollarama’s current shrink
provision remains low (estimated at less than 2%) the likelihood of a material
inventory write-down, similar to that of Dollar Tree, may be high if Dollarama
chooses to separate its inventory into more than one pool. This potential write
down could largely offset the labour cost savings expected from the POS
system, though it is difficult to quantify given Dollarama’s lack of disclosure on
inventory management and its use of the retail method.
SEPTEMBER 19, 2012
v
20
DOLLARAMA INC.
We could not confirm that Dollarama uses a single inventory pool for
accounting purposes. The possibility of a future shrink adjustment is based on
Dollar Tree’s experience, which may not be relevant for Dollarama.
DOLLARAMA’S GROWING STOCK PILE OF CASH
DOL is positioned
well to deliver
excess cash to
shareholders
Since going public in Oct 2009, Dollarama has reduced its net debt level from
$487 million to $171 million, as of Q2-F2013. As a result, interest expense has
continued to drop while free cash flow generation has been stellar, which will
allow Dollarama to continue paying down debt while expanding aggressively.
We estimate interest expense at $9.8 million in F2013, which implies an interest
coverage ratio of 32.3x. Dollarama had over $94 million in cash as of Q2F2013, and we forecast the company will generate roughly $190 million in free
cash flow this year.
Dollarama stores typically cost $600,000 to open, with $400,000 for capital
expenditures and $200,000 for inventory. New stores generate roughly $2.0
million in sales during the first year and recover the initial investment within two
years. Assuming rent expense inflation of roughly 3.5% to 4.0%, we estimate
Dollarama will incur capital expenditures of $60 million in F2013 and will peak
at $68 million F2016, which will be comfortably financed with free cash flow.
We expect the remaining cash to be returned to shareholders in the form of
higher dividends, with sustainable and consistent increases over the next
several years. The company has also initiated a normal course issuer bid to
purchase up to 3.5% of outstanding shares, but we anticipate Dollarama will
favour dividend increases over buybacks until the stock price has pulled back
from current levels.
DOLLAR TREE: DOLLARAMA’S FIRST REAL TEST
Dollarama has dominated the Canadian dollar store industry over the past
decade, as independent rivals have shrunk in size while Dollarama has rapidly
expanded across the country. However, things quickly changed when Dollar
Tree acquired Dollar Giant in October 2010. Suddenly the Canadian market
had a new dollar store chain in town, one with deep pockets and vast
experience in the space. Although our proximity analysis suggests the
Canadian market can handle substantial growth from both Dollarama and
Dollar Giant for at least four more years, we are concerned Dollarama stores
in close proximity to Dollar Tree may suffer market share loss as both
companies continue to expand.
Dollar Tree is Dollarama’s most comparable competitor, but the U.S. retailer
does have some distinct differences. Unlike Dollarama, Dollar Tree operates on
a single price point strategy. Each and every item in Dollar Tree’s Canadian
stores is priced at $1.25 or less. Our August 2012 price survey revealed the total
basket price for 52 general merchandise items was $46.90 at Dollarama and
$46.77 at Dollar Tree, after adjusting for differences in quantity and size. Of the
52 items in the basket, roughly 16% were priced at parity, while 46% of the
items were priced higher at Dollar Tree. Unlike Walmart, Dollar Tree is a fierce
competitor on price and is the only major single price point retailer in Canada.
Thus, Dollarama has limited flexibility to pass through price increases as they
now face a price ceiling of $1.25, courtesy of Dollar Tree.
While we believe Dollarama’s multiple price point strategy will be a positive
catalyst for the company, Dollarama faces the risk of losing its image as a true
dollar store retailer. The multiple price point strategy forces Dollarama to
v
September 19, 2012
DOLLARAMA INC.
21
allocate only a portion of its SKU’s in the $1.00 price range, while Dollar Tree
has no limitation due to its single price point model. This could have a
psychological impact on the market, as consumers may implicitly assume
Dollar Tree has lower prices compared to Dollarama simply because every
item in the store is $1.25 or less. Unlike the U.S. dollar store industry, there is no
major competitor in Canada that has bridged the gap between a single price
point dollar store and a full-scale mass merchant. Thus, Dollarama is not at risk
of stepping into another competitor’s territory by introducing higher price
point items, so long as they maintain their core offering of products at the
$1.00 price point. However, Dollar Tree’s single price point model may draw
customers away from Dollarama, especially those looking to only spend a few
dollars.
Although Dollarama and Dollar Tree have significant SKU overlap, Dollar Tree
sources more of its merchandise from U.S. suppliers, carries more national
brands and has fewer private label items. Our observation of similar products
offered at both stores suggests Dollar Tree offers better quality products with
superior packaging compared to Dollarama. Consumers concerned with
product quality and brand names may favour shopping at Dollar Tree versus
Dollarama, although we would not classify dollar store shoppers as consumers
overly concerned with quality. Pictures of a Dollar Tree store we visited in
Cheektowaga, New York can be seen in Appendix C.
With over 4,500 stores in the U.S. and Canada and a healthy cash balance of
$380 million, Dollar Tree’s economies of scale and purchasing power
dominate those of Dollarama. If faced with significant inflationary pressures,
we believe Dollar Tree will have more leverage in negotiating lower prices
relative to Dollarama. Dollar Tree will eventually rebrand all Dollar Giant
locations under the Dollar Tree banner, which will help create a homogenous
brand image and improve consumer familiarity.
In Figure 14, we have determined the number of Dollar Tree locations located
in the same FSA as a Dollarama store, as of August 2012.
Figure 14
Number of Dollar Tree stores in the same FSA as Dollarama
Province
Alberta
British Columbia
Manitoba
New Brunswick
Newfoundland and Labrador
Northwest Territories
Nova Scotia
Nunavut
Ontario
Prince Edward Island
Quebec
Saskatchewan
Yukon Territory
# of Dollar Tree in same FSA as Dollarama
11
18
1
0
0
0
0
0
42
0
0
3
0
Total
75
Total Dollarama Stores
Total Dollar Tree Stores
735
118
% of Dollarama Store Base
% of Dollar Tree Store Base
10%
64%
DLTR has only
penetrated 10% of
DOL’s store base
Source: Veritas estimates.
SEPTEMBER 19, 2012
v
22
DOLLARAMA INC.
Since Dollar Tree acquired the majority of its current store base through
purchasing 85 Dollar Giant locations in 2009, we cannot assume the current
level of overlap will persist as both chains continue to grow. However, given
Dollar Tree’s long term goal is to open 1,000 stores, we believe the company
will be forced to open locations in close proximity to Dollarama as the number
of optimal locations continues to decrease. The results of our proximity analysis
suggest both retailers can grow at 60 stores annually over the next four years,
primarily in FSA’s with no dollar store presence. However, this assumption could
prove to be conservative in the event the dollar store chains expand into
each other’s territory. Thus, we present a scenario analysis assuming different
rates of overlap for new locations over the next four years in Figure 15.
Figure 15
Sensitivity Analysis of Dollar Tree’s Penetration of Dollarama’s Store Base
% of Dollarama Store Base in Same FSA as Dollar Tree Locations
Annual Overlap Rate
for New Locations
10%
F2013E
F2014E
F2015E
F2016E
F2017E
11%
12%
13%
13%
13%
30%
11%
15%
18%
20%
22%
60%
11%
19%
25%
31%
35%
80%
11%
21%
30%
38%
44%
Source: Veritas estimates.
The annual overlap rate for new locations refers to the percentage of new
store locations opened by both Dollarama and Dollar Tree in FSA’s with an
existing dollar store presence. We believe the overlap rate will average 30%
over the next four years, which implies Dollar Tree will overlap less than 15% of
Dollarama’s store base by the end of F2014. However, if the overlap rate is
closer to 60%, Dollar Tree locations will be in proximity to roughly 19% of
Dollarama’s locations by the end of F2014.
Dollarama is immune to competition in Quebec where more than 30% of its
total stores are located and only two other competitor locations exist.
However, this could change if Dollar Tree decides to penetrate the Quebec
market. Given Dollarama is currently six times larger than Dollar Tree, our
forecasts indicate Dollar Tree cannot grow fast enough over the next two
years to have a significant impact on Dollarama’s results. However, we
believe Dollarama will suffer a more pronounced decline in traffic and
average volumes beyond F2014, and thus we anticipate SSSG will flatten at
4% from F2015 onwards.
VALUATION
Figure 17 shows the assumptions for Dollarama which supports our intrinsic
value estimate of $66.00, derived using a discounted cash flow model.
v
September 19, 2012
DOLLARAMA INC.
23
Figure 17
Assumptions in Our Dollarama Model
(Amounts in millions of Canadian dollars, except number of stores and EPS)
Assumptions
F2011
F2012
F2013E
F2014E
F2015E
F2016E
F2017E
F2018E
F2019E
F2020E
Same Store Sales Growth
4%
7.3%
4.5%
7%
7%
4%
4%
4%
4%
4%
New Store Openings
49
52
68
60
60
60
26
10
10
10
Total Stores
652
704
772
832
892
952
978
988
998
1,008
Square Footage Growth
9%
8%
10%
8%
8%
7%
3%
1%
1%
1%
43.00%
Gross Margin
42.11%
43.41%
43.26%
43.00%
43.00%
43.00%
43.00%
43.00%
43.00%
SG&A Margin
19.65%
19.04%
18.25%
17.52%
16.79%
16.55%
16.49%
16.40%
16.31%
16.22%
(0.61%)
(0.79%)
(0.73%)
(0.73%)
(0.24%)
(0.06%)
(0.08%)
(0.09%)
(0.09%)
Change in SG&A Margin
Rent Margin
5.98%
5.95%
5.83%
5.77%
5.84%
5.88%
5.90%
5.89%
5.87%
5.86%
EBITDA Margin
16.48%
18.42%
19.17%
19.71%
20.37%
20.57%
20.61%
20.70%
20.81%
20.92%
1.94%
0.76%
0.53%
0.66%
0.20%
0.04%
0.09%
0.11%
0.11%
$1,420
$1,603
$1,843
$2,115
$2,343
$2,583
$2,795
$2,953
$3,099
$3,251
13%
15%
15%
11%
10%
8%
6%
5%
5%
$234
$295
$353
$417
$477
$531
$576
$611
$645
$680
26%
20%
18%
14%
11%
8%
6%
5%
5%
$1.55
$2.30
$2.92
$3.50
$4.11
$4.58
$4.97
$5.27
$5.56
$5.86
Y-o-Y EPS Change
49%
27%
20%
17%
11%
8%
6%
5%
5%
Discount Rate
9.5%
Change in EBITDA Margin
Sales
Y-o-Y Sales Change
EBITDA
Y-o-Y EBITDA Change
FD EPS
Terminal Growth Rate
3%
Intrinsic Value
$ 66.00
Source: Veritas estimates.
Figure 18 shows the sensitivity of our intrinsic value using various discount rates
and terminal growth rates.
Figure 18
Terminal Growth Rate
Sensitivity of Our Intrinsic Value for Dollarama
Discount Rate
9.0%
9.5%
10.0%
0%
$54
$50
$47
1%
$58
$54
$51
2%
$64
$59
$55
3%
$72
$66
$61
4%
$83
$75
$68
Source: Veritas estimates.
Dollarama enjoys a significant premium relative to its U.S. competitors, on both
a P/E and EV/EBITDA basis, as seen in Figure 19. We believe the current
premium is justified, given Dollarama’s strong growth prospects in an
underpenetrated Canadian market, industry leading margins, market share
dominance and significant benefits yet to be released from current
productivity initiatives. We anticipate Dollarama will post strong results for the
remainder of F2013, particularly Q3-F2013, and reach our intrinsic value
estimate of $66.00 within 12 to 18 months.
SEPTEMBER 19, 2012
DOL’s premium
valuation relative to
U.S. comparables is
justified
v
24
DOLLARAMA INC.
However, we caution investors of the risk of a multiple contraction in the event
Dollarama fails to meet expectations. We believe competitive pressures will
begin to impact Dollarama’s results beyond F2014, especially as the multiple
price point strategy is exhausted and Dollar Tree continues to expand. The
market has priced in strong growth assumptions for Dollarama, leaving the
company with little room for error. When priced for perfection, perfection must
be delivered!
Figure 19
Valuation Metrics for Dollar Store Chains
Current
Price
F2012E
EPS
F2013E
EPS
EPS
F2012E
Growth
F2013E
P/E
P/E
F2012E
FCF
F2013E
F2012E
F2013E
FCF
FCF
Yield
FCF
Yield
Dollarama
$59.00
$2.92
$3.50
20%
20.2x
16.9x
$3.40
$4.09
5.8%
6.9%
Dollar Tree
$46.90
$2.52
$2.89
15%
18.6x
16.3x
$3.25
$3.61
6.9%
7.7%
Dollar General
$50.02
$2.84
$3.34
17%
17.6x
15.0x
$3.64
$4.22
7.3%
8.4%
Family Dollar
$64.22
$3.64
$4.21
16%
17.6x
15.2x
$5.41
$6.15
8.4%
9.6%
Current
F2012E
F2013E
F2012E
F2013E
F2012E
F2013E
EBITDA
F2012E
F2013E
Price
Sales
Sales
EBITDA
EBITDA
EBITDA
EBITDA
Growth
EV/
EV/
Margin
Margin
EBITDA
EBITDA
Dollarama
$59.00
$1,843
$2,115
$353
$417
19.17%
19.71%
18%
13.1x
11.1x
Dollar Tree
$46.90
$7,447
$8,070
$1,113
$1,235
14.95%
15.30%
11%
10.0x
9.0x
Dollar General
$50.02
$16,128
$17,702
$1,969
$2,220
12.21%
12.54%
13%
10.2x
9.0x
Family Dollar
$64.22
$9,328
$10,350
$907
$1,026
9.72%
9.91%
13%
9.2x
8.2x
Source: Bloomberg, Veritas Estimates. (EPS and EBITDA margins are based on consensus, except Dollarama’s estimates are
Veritas estimates)
CONCLUSION
With 735 stores across Canada, Dollarama is the only dollar store chain with a
national presence and is now larger than the remaining five largest Canadian
dollar store competitors combined. Dollarama’s multiple price point strategy
has enhanced its value proposition, as the company continues to expand its
assortment while maintaining its prices for items at the $1.00 price point.
Our proximity analysis suggests there is enough room in the Canadian market
for Dollarama to reach its goal of 900 to 1,000 stores without risking saturation.
As Dollar Tree continues to expand, we believe it will penetrate more of
Dollarama’s existing markets, which will undoubtedly limit Dollarama’s long
term SSSG and market share growth. However, our analysis suggests Dollar
Tree cannot grow fast enough to have a material impact on Dollarama’s
existing stores over the next two years. We derive an intrinsic value estimate of
$66.00 for Dollarama, implying the company has roughly 13% upside from
current share price levels.
BUY.
v
September 19, 2012
DOLLARAMA INC.
25
APPENDIX A – DOLLARAMA PRODUCT OFFERINGS AT $2.50 AND $3.00
Remote Control $3.00
Snuggie for Kids $3.00
Step Stool $3.00
Stapler $3.00
Stainless Steel Knife Set $3.00
Poker Chips $2.50
Source: Veritas.
SEPTEMBER 19, 2012
v
26
DOLLARAMA INC.
APPENDIX B
SURVEY USED AT DOLLARAMA STORES
MARKETING PROJECT: DOLLARAMA’S CUSTOMER PROFILE
a. Female
a. <29
a. <$40,000
Sex:
Age:
Annual income level:
1.
c. >50
c. $60,000+
How far do you live from this Dollarama location?
a)
<20 minutes drive
b)
> 20 minute drive
2.
The primary purpose of my visit today was to purchase:
a) Food other than candies
b) Household items
c)
General merchandise
3.
How many items did you purchase today?
4.
How much did you spend?
a) < $5
b) $5 - $10
c)
> $10
5.
Do you think prices at Dollarama have increased over the past year?
6.
v
b. Male
b. 30-49
b. $40,001-$60,000
a)
yes
b)
no
I plan my visit to (as opposed to an impulse visit):
a) Dollarama
yes
b) Walmart
yes
c)
Zellers
yes
no
no
no
7.
How often do you shop at Dollarama in a typical month?
a) Rarely
b) Once per month
c)
2-5 times per month
8.
I compare prices between:
a) Dollarama and Walmart
b) Dollarama and Zellers
c)
Dollarama and No Frills
9.
I would not buy from Dollarama if the price of a $1 dollar item increased by:
a) 25 cents
b) 50 cents
c)
$1
10.
Which store do you think offers the best value?
a) Dollarama
b) Walmart
c)
Zellers
d) No Frills
September 19, 2012
DOLLARAMA INC.
27
APPENDIX C
PICTURES OF A DOLLAR TREE STORE IN CHEEKTOWAGA, NY
Dollar Tree, Buffalo
Greeting Cards $1 for 2
Dairy and Frozen Foods
Nestle Water and Other Beverages
School Supplies
Trial and Travel
Source: Veritas.
SEPTEMBER 19, 2012
v
28
DOLLARAMA INC.
APPENDIX D
THE RETAIL INVENTORY METHOD
Under the retail method, inventories are converted to a cost basis by applying an average cost-to-retail
ratio which directly impacts reported gross margin. Many retail companies utilize the retail inventory
method and we have no evidence Dollarama is manipulating the accounting of inventory to its
advantage. Nonetheless, the retail method has the following drawbacks:

Since margin is not calculated until the end of each month, management can game the inventory
by delaying necessary markdowns, underestimating shrink or withholding shipments;

The retail inventory method assumes the cost-to-retail ratios are homogeneous across product
categories. This can be problematic when a company carries private label items and sources
inventory from off-shore suppliers, as all products can potentially be placed in the same inventory
pool but have different mark-up percentages; and

Assumptions regarding shrink, estimated selling price and other details are generally not disclosed
by companies using the retail inventory method, making it difficult to assess the reliability of gross
margin and inventory.
v
September 19, 2012
DOLLARAMA INC.
29
APPENDIX E
THOUGHTS ON WALMART’S DOLLAR PROGRAM
Walmart Canada launched its “Dollar Program” in 2011 by looking at competitors’ top traffic driving areas
and it now offers products in food, home lines, and hardware. The degree to which this program will impact
Dollarama is highly dependent on the number of SKU’s and square footage devoted to the Dollar Program
in Walmart stores. After visiting two Walmart stores in Scarborough and Mississauga, we observed less than
two aisles specifically devoted to the dollar program and many of the same products were priced higher
at Walmart compared to Dollarama. We do not believe Walmart can compete with Dollarama’s breadth
and seasonal selection of dollar store items. Walmart customers will purchase items in the Dollar Program
based on convenience rather than value or preference. Since Dollarama strategically opens stores in close
proximity to Walmart locations, we believe the market share bleed from the Dollar Program will be limited
as customers have the choice to visit a Dollarama after their Walmart trip for better value and selection,
often right around the corner from the mass merchant.
If Walmart continues to expand its selection of products in the dollar program, consumers may opt to skip
their Dollarama trip and fill their entire basket at Walmart instead. Walmart has the ability to undercut
nearly any retailer in the world and should they choose to target Dollarama directly, we believe they would
be successful in stealing market share. Time will tell whether Walmart decides to expand its Dollar Program,
but we do not expect it to be a threat in the near term to Dollarama.
SEPTEMBER 19, 2012
v
BUY
DOLLARAMA INC.
TSX—DOL
C$58.11
Current Yield: 0.7%
September 19, 2012
ANOTHER LOOK AT DOLLARAMA
Dollarama’s business model has proven to be more resilient than we anticipated, as the company has continued to deliver strong top line and
bottom line growth. After an extensive review of our previous thesis, we believe the company has upside in the near term. Our proximity
analysis of the Canadian dollar store industry shows there are roughly 468 optimal locations for new dollar stores to open and, as a result, we
expect Dollarama will comfortably reach its goal of 900 to 1,000 total stores by F2017. Our price survey shows items in the $1.00 range are
priced 13% higher at Walmart and on par with Dollar Tree. We anticipate Dollarama will continue to selectively introduce higher price points
as a means to drive same store sales growth, while maintaining its core offering of items in the $1.00 range. We believe Dollarama will face
competitive headwinds in the long term, but given their commanding market share, we do not expect competitive pressures to have a
material impact on Dollarama’s results over the next two years. We have upgraded our recommendation to BUY on Dollarama.
QUALITY RATING
INTRINSIC VALUE
Accounting & Disclosure
3/5
Given the results of our proximity analysis and the introduction of
items above the $2.00 price point, we believe Dollarama should
deliver strong results over the next 12 to 18 months. We expect Q3F2013 to be particularly impressive, given the weak year-over-year
traffic comparison. Our intrinsic value of $66.00 for Dollarama implies
19x F2014 P/E or 12x F2014 EV/EBITDA.
Dollarama’s disclosures are on par with those of other Canadian
retailers. However, the lack of disclosure on its use of the retail inventory
method makes it difficult to accurately estimate shrink and margins.
Adjusted Cash Flows
4/5
We expect Dollarama to continue generating strong free cash flow,
reaching $190 million in F2013. Current productivity initiatives will likely
offset minimum wage increases over the next two years.
The Balance Sheet
Dollarama is a de-leveraging story and we expect future cash flows will
be used to pay down debt on the balance sheet. Since going public in
Oct 2009, Dollarama has reduced its net debt level from $487 million to
$171 million, as of Q2-F2013. We estimate interest expense at $9.8
million in F2013, which implies an interest coverage ratio of 32.3x.
Business Operations
3/5
DOL has more than doubled its store network over the past eight years,
while rival dollar stores have seen their market share shrink by nearly
40%. DOL is now Canada’s largest dollar chain and is unparalleled at
providing its consumers with disposable-type value merchandise. DOL’s
multiple price point strategy has allowed the company to broaden its
product offering while maintaining its core offering of products at the
$1.00 price point. DOL began utilizing its POS system as the primary
source for replenishment purposes in July 2012 and we anticipate the
use of the POS system will improve inventory turns for DOL over the next
two to three years.
Corporate Governance
3/5
Dollarama has nine directors, of which five are independent. 6% of
shares are owned by Larry Rossy, the CEO.
Torpedo
4F2014E
F2013E
F2012
Normalized FD EPS
$3.50
$2.92
$2.30
Revenue
2,116
1,843
1,603
EBITDA
417
353
295
EBITDA Margin
19.71%
19.17%
18.42%
Price
$58.11
$58.11
$33.16
P/E
20.2x
16.9x
14.4x
Price/Book
4.1x
3.4x
2.8x
Market Capitalization
4,460
4,460
2,498
EV
4,336
4,506
2,700
EV/EBITDA
10.4x
12.8x
9.1x
Weighted Average
FD Shares Outstanding (millions)
75.4
75.4
75.4
FY end January 31 (C$ millions,
except per share amounts)
4/5
Risky
Neutral
Better
Best
Quality Scale
5
10
15
20
25
Intrinsic Value Scale
-50%
KATHLEEN WONG
-25%
0
25%
50%
[email protected]
416-866-8783
Veritas Investment
Research Corporation
Director of Research
Neeraj Monga, MBA
Accounting & Special Situations
Telecommunications & Technology
Anthony Scilipoti, CA, CPA
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[email protected]
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[email protected]
Dimitry Khmelnitsky, CA
[email protected]
Energy & Special Situations
Graham Goulet
[email protected]
Sam La Bell, MBA
[email protected]
Financial Services
Michael Levshin
[email protected]
Ohad Lederer, CA, CPA, CFA
[email protected]
Gold
Retail & Consumables
Pawel Rajszel
[email protected]
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[email protected]
Marc Giampuzzi
[email protected]
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[email protected]
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Varun Anand
[email protected]
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[email protected]
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