Stock investors have to accept the fact that opportunities will be missed. Strictly adhering to the methodology that suits you best — in our case contrarian, value-based investing — has been shown to improve the chances of spotting scintillating prospects. Specifically, we look for resilient companies that have traded for a long time but have been tossed aside by investors for reasons that we believe are eventually surmountable. Yet every now and then, we peek outside of our financial ecosystem at a stock which didn’t meet our criteria but we would have loved to own.
Dollarama is such an organism. While it is easy to be dismissive of anything whose name ends in “arama” (think “Bananarama”), this Canadian company has a first-rate business reputation and its shares have returned over 800 percent since they started trading in 2009. Is it possible that anyone reading this has never gone into one of its stores with the familiar signage of bold, yellow letters and a loonie on a green background? Most people likely have, even those who claim to loathe cheap, imported goods. The variety of offerings is enticing, combined with the convenience of happening upon one of Dollarama’s 1,030 locations. The retailer is like the Tim Hortons of dollar stores, which is another stock that we had a crush on but was a square peg to our round doughnut hole.
When we first start to look closer at Dollarama, we can’t help but be contrarians. The retailer has a rich executive compensation structure combined with a lot of long-term debt that hasn’t been paid down, even with the fat profits the company has generated. Also, the book value dropped during this latest quarter to under $4 a share and if you strip out goodwill, the net asset value is negative. That for a stock that trades around 90 bucks — not the feed of value guys like us.
Still, the company has qualities to rave about. It has a great record for beating already optimistic analyst estimates on both the top and bottom lines. For fiscal 2016, comparable-store sales were up an impressive 7.3 percent and gross margin skipped from 37 to 39 percent. Operating income grew 30 percent to $549 million and total revenue was $2.65 billion. Profit was a healthy $385 million or $3 a share, even though the drop in the Canadian dollar was tough on most Canuck retailers.
Management at this corporation has been very astute and the company has a great family history. So it was significant when Dollarama announced that chief executive Larry Rossy would hand the CEO reins to his son Neil on May 1. A succession plan with nepotism at the forefront can be a potential red flag, but this does not appear to be the case here. Neil has been with the company since its founding in 1992, is a board member, and recently was the chief merchandising officer. Clearly, he has been an integral part of the company’s operations.
Dollarama has some strong levers to pull to improve in fiscal 2017. A key one is that the retailer plans to change its product mix somewhat and introduce $3.50 and $4 items. Plus, it has clout when it comes to getting better pricing in a softening demand environment in China, where many of its products are sourced. The dividend is growing slowly, currently at 10 cents a share, and the company is buying back shares. The plan is for ongoing location growth, and after the initial set-up expenses, the bottom line should be bolstered.
Competition is not fierce for Dollarama. US chain Dollar Tree is in Canada, with 227 stores according to its store locator, and the company’s pitch is that every piece of ephemera is priced at $1.25. Dollar Tree recently bought out a competitor, Family Dollar. While one can argue that the American dollar-store market is saturated, Canada’s is not, so Dollarama is exploiting every opportunity to grab great locations and maintain its huge market share.
While Dollarama is one of the great Canadian growth stocks, many analysts consider to it be a superb defensive addition to a portfolio, especially when the economy goes south. Yet the company maintains that its sales are not driven by bad economic conditions and that it does well through thick and thin.
What about buying into this outfit? Only five years ago, this was a $15 stock and right now it trades around $90, near the historical high. Perhaps momentum buyers would find this company endearing but we would be exceedingly wary. From our vantage point, there are lots of better deals in the stock market by virtually any metric.