This Beaten-Down Retailer is a Screaming Bargain

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We are a nation of discount shoppers. Just like stock market investors love to buy shares at a discount, consumers love to find bargains when shopping.

Retailers exploit this discount purchasing desire in numerous ways. Consumer savvy sellers do everything from issuing discount coupons and participating in loss-leader Groupon-type programs, to holding sales events and carefully setting price amounts to psychologically pleasing figures.

Discount shopping is such a dominant force that the International Monetary Fund listed discount retailer Walmart (NYSE: WMT) as 28th on the list of the world’s largest economies in 2013. This means that the discount retailer’s economic power is greater than most nations, serving as a testament to the success of the discount shopping model.

The Next Level Of Discount Shopping
An entire industry has emerged pushing the discount concept to the extreme in the brick & mortar space. Known as dollar stores, these deep-discount retailers have become a thriving industry, while creating over $25 billion in annual revenue.

Dollar stores are defined as stores that sell most of their merchandise at a single low price. As the name suggests, the price is generally $1.00 or so per item. These retailers focus on regions that are considered too small to support a Walmart, yet have enough of a population to allow the dollar store concept to thrive.

In September 2014 a survey conducted by Symphony IRI revealed that approximately 65% of all consumer packaged goods were purchased in dollar stores. This figure indicates the closing gap between mass merchandisers, supercenters, and dollar stores, and is an incredibly bullish metric.

Right now there is tremendous opportunity in both of the leading dollar store retailers, Dollar General (NYSE: DG)and Dollar Tree (NYSE: DLTR).¬† In 2015, Dollar General’s net sales hit just under $20.50 billion, while Dollar Tree posted net sales of approximately $15.5 billion.

I believe that there is opportunity in both stocks. However Dollar Tree appears to offer the best opportunity right now for investors.

Dollar Tree, a Fortune 200 Company, ran 14,129 stores across 48 U.S. states and five Canadian provinces as of the end of the second quarter. Stores operate under the brands of Dollar Tree, Family Dollar, and Dollar Tree Canada. According to results posted on August 22 the company performed well in the second quarter of 2016, with net sales growing by nearly 66% to $5 billion, up from $3 billion in the same period last year. (Third quarter 2016 results are expected in November.)

Once adjusted for the impact of Canadian dollar changes, same-store sales posted growth of 1.1%. This positive same-store sales growth was driven by increases in both customer count and average ticket, meaning that not only is the company attracting more customers, those who visit are spending more.

Gross profit ramped higher by just over $657 million, or nearly 77%, to $1.51 billion in the second quarter, compared to $855.2 million year over year. The increase was predicated upon just over $588 million of gross profit for Family Dollar, as well as a 9% increase in Dollar Tree’s gross profit in the second quarter.

Bob Sasser, Chief Executive Officer, stated, “I am very pleased with the Company’s overall performance in our second quarter. Through what continues to be a challenging retail sales environment, we delivered gross margin improvement and managed expenses actually to provide earnings at the top end of our guidance range. In our Dollar Tree segment, we improved our operating margin and delivered our 34th consecutive quarter of positive same-store sales.”

Despite these great numbers, Wall Street focused on the EPS estimate miss during the second quarter. The estimate of $0.73 was slightly over-optimistic with the actual number coming in at $0.72. The stock price was slashed lower by over 20% in an irrational reaction, which has created an ideal buying opportunity for these shares.

Risks To Consider: Deutsche Bank has lowered its target price despite maintaining a buy rating on the shares.  The investment bank cites margin concerns and weak consumer traffic as reasons for the lower price target.

Action To Take: Technically, shares have set up to be ideal rebound play. The stock price bounced solidly from the lows, with the next resistance level being $79.00 per share. Enter long on a breakout above $79.00 per share with initial stops set at $75.67 per share to allow for the inherent price volatility.  Our target price is $96.00 per share.

David Goodboy does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.