More than two years after activist investor Starboard Value pulled a proxy fight at Dollar Tree, the retailer remains highly vulnerable to shareholder activism. According to Activist Insight Vulnerability, Dollar Tree is in the 92nd percentile of companies most vulnerable to shareholder activism in the next nine months and is the most vulnerable retailer from the S&P 500 Index.

Dollar Tree’s key issues are weak valuation relative to peers, weak revenue growth, poor margins, and high shareholder opposition against two directors.

Activist thesis

Starboard withdrew its slate of nominees after the company agreed to explore multiple price points like its peers to allow it to improve the quality of the merchandise. Two years on, the rollout appears to be moving too slowly, while the acquisition of Family Dollar continues to detract from profitability.

Starboard at the time called for a potential divestment of Family Dollar. An activist could demand the same thing as a way to crystallize shareholder value more quickly. It could also push for more urgency in turning around Family Dollar, a clear focus on cost cuts, and profitability improvement.

Business structure

Dollar Tree is a U.S. chain of discount variety stores with a market capitalization of $23 billion. The company acquired competitor Family Dollar for $9 billion in 2015 after a brief bidding war with Dollar General. The company has more than 15,000 stores, roughly equally divided between Family Dollar and Dollar Tree brands.

However, due to Family Dollar’s different business model and mismanagement, integrating the brand has been time-consuming and costly. Family Dollar primarily sells items in the $1 to $10 price range, while Dollar Tree sells items for $1 or less. Some analysts have said in the past that Family Dollar’s supply chain is poor as there are a lot of out-of-stock items.

Dollar Tree’s initiative to introduce merchandise with price points ranging from $1 to $5 has been accelerating very slowly. The company implemented the new strategy at 100 stores as a test and plans to expand it to another 500 stores this year.

Peers and industry

While Dollar Tree has struggled to integrate Family Dollar and move with enough urgency on the multiple price point initiative, its peers have thrived. Dollar General and Five Below have posted strong revenue and earnings growth, acquiring market share from Dollar Tree.

The macroeconomic environment is not kind to Dollar Tree. As wages and merchandise costs rise, the company will have a hard time passing on higher costs to the consumer given its fixed price point. “For wages, low-income wage growth and total wage growth is at the highest levels since [Dollar Tree’s] IPO in 1995. Meanwhile, the job quit rate in the broader retail sector is at a 20 year high. We estimate a $1/hour pay increase to store associates would represent a $215 million headwind,” Piper Sandler analysts said last month.

Financials

Indeed, the company’s main weaknesses are its margins, revenue growth, and high costs. The company has grown its revenues at an annualized rate of 4.5% over the past three years, versus 12% for Dollar General and 20% for Five Below. Its net operating margin of 8% is lower than Dollar General’s 10.7% and Five Below’s 12.3%.

The low margins could largely be attributed to Family Dollar. The Dollar Tree unit sports operating margins of 12%, as of the fiscal year ended January 2021. Family Dollar’s margins are a little higher than 5%.

The low operating margins are also due to higher general and administrative costs (SGA). Dollar Tree’s SGA costs make up 23% of revenues versus 21.6% for Dollar General.

Performance and valuation

As a result, investor confidence in the stock is low. According to Activist Insight Vulnerability Dollar Tree’s five-year total shareholder return is 5% versus 140% for Dollar General and 317% for Five Below.

Its valuation is also weak, as the stock trades at a price-to-earnings ratio of 15.9 versus 20 for Dollar General and 48 for Five Below. If Dollar Tree can bring its revenue growth and operating margins in line with Dollar General, its stock can benefit both from earnings per share increases and multiple expansion.

Corporate governance and management

The company’s board could do with some refreshment. Four directors, including Chairman Bob Sasser, have served for more than 13 years. At the last annual meeting on June 10, directors Lemuel Lewis, 14 years as director, and Thomas Whiddon, 17 years, received 10% and 11% of votes against them, respectively. Most shareholders have cited the long tenure of these two directors when voting against their re-election, according to Proxy Insight Online.

Other governance red flags include the lack of shareholder right to call special meetings or act by written consent and no independent chairman.

Shareholder register

Vanguard, BlackRock, and State Street, the three passive funds that are less likely to side with dissidents, collectively own around 24% of the stock. Other top 10 shareholders include T. Rowe Price, which voted on the dissident card in 45% of proxy contests; Fidelity, which backed dissidents in 29.5% of the proxy fights; and Lazard, which supported dissidents 54% of the time.

DISCLAIMER: Activist Insight Vulnerability reports use proprietary data, along with third-party analyst reports and, in certain cases, interviews with industry sources to identify companies that might become activist targets. They represent an analytical attempt at predicting companies that may be engaged by an activist from a wide range of possible targets and are in no way intended to indicate that a speculated event is imminent or will take place. Insightia does not provide investment advice or accept responsibility for the result of trades based on Activist Insight Vulnerability reports or descriptions of Activist Insight Vulnerability reports by third-party media.