Dollarama: Strong Execution of Growth Plans Drives Stronger Margins (OTCMKTS: DLMAF)

introduction

It’s been over nine months since I last discussed Dollarama (OTCPK:DLMAF), and as the company prepares to release its annual financial results (the fiscal year ends in January, so the annual results announcements are only a few months away), it’s a good time to catch up on history. Dollarama has benefited from the favorable winds related to the COVID, but it seems that inflation could become an issue in the near future, as labor and transportation expenses are likely to increase.

Dollarama’s most liquid listing is in Toronto, where it trades with DOL as a stock symbol. The average daily volume in Toronto is around half a million shares. The current market cap, based on the 298 million shares outstanding, is approximately C$18 billion.

Margins are up, and that’s good for free cash flow

Dollarama’s stock price is trading about 10% higher than in April of last year, which is perhaps a little surprising since the company has posted strong results in recent quarters.

In the third quarter of fiscal year 2022, for example (the fiscal year ends on January 31), Dollarama recorded a 5.5% increase in revenue which included a 0.8% increase in comparable store sales. This was a welcome surprise, as it actually builds on the momentum generated by the dollar store in the prior fiscal year, in which its same-store revenue grew from a high percentage to a figure.

Not only is revenue increasing, but Dollarama is also becoming more efficient as its gross margin increased to 44.4% (from 44%), while EBITDA margin increased to 30.9% of revenue from just 29.3 % revenues. Looking at the performance for the first nine months of the year, the EBITDA margin was approximately 28.6%, compared to 27.5% in the first nine months of fiscal 2021 (these nine months ended on November 1, 2020, so they included the full impact of the accelerating pandemic that year).

Looking at the 9M 2022 results, total revenue was just over C$3.1 billion, resulting in gross profit of C$1.35 billion. That’s a very nice increase from C$1.26 billion to 9 million for FY2021. Meanwhile, I was a bit surprised to see that SG&A spending only increased by 1 .5%. I would have thought that the salary increases would have resulted in a larger increase in total selling, selling, and administrative expenses, but Dollarama may also have had to reverse some of its COVID measures. Despite the opening of additional stores, we see that SG&A spending actually declined in the third quarter. Just 1% to C$159 million, but that’s a very interesting development.

Reported net income of C$183.4 million and C$443.2 million represented EPS of C$0.61 and C$1.45 per share respectively, but readers are cautioned that EPS is based on the average number of shares of 301 million shares and 305 million shares, respectively. While Dollarama is aggressively repurchasing shares (see below), the number of shares as of October 31 was approximately 298 million shares, which means that if we applied reported net income to the number of existing shares rather than ‘At average number of shares, we would see EPS of C$1.49 in the first nine months of the year.

Dollarama’s robust results also indicate that the company offers strong cash flow. In the first nine months of the fiscal year, Dollarama reported operating cash flow of C$679 million before changes in working capital position, but this includes approximately C$16 million in deferred taxes and excludes C$136 million in lease payments. On an adjusted basis, cash flow from operations was approximately C$527 million (compared to C$470 million on FY2021’s C$9 million, again underscoring the strength of the results since the beginning of the year).

Total capex was approximately C$110 million, resulting in a reported free cash flow result of C$417 million. It is important to note that capital expenditures include all growth expenditures. Dollarama expects to open 60 to 70 new stores in the current fiscal year and we should expect a substantial portion of the investments to be tied to these growth plans. Keep in mind that the depreciation expense excluding the lease portion is only C$85 million and Dollarama has spent almost C$110 million on tangible and intangible investments. I’d like to argue that a substantial portion of the C$110 million of investments is actually growth-related and the underlying free cash flow is likely closer to or greater than C$450 million.

Dollarama continues to buy back shares

That’s a lot of free cash flow and Dollarama is spending all of it (and even some of it) buying back its own stock. The dollar store pays a dividend, but since the quarterly dividend is only C$0.0503/share for a dividend yield of just under 0.35%, it’s clear that dividends are not not high on the priority list.

Dollarama prefers to buy back its own shares because it will create longer-term value. In the third quarter, approximately C$295 million was spent to repurchase shares, bringing the total of 9 million for fiscal year 2022 to 741 million Canadian dollars. During Q3 and the 9 month period, Dollarama repurchased 5.27 million and 13.1 million shares respectively, reducing the number of shares by approximately 4%. While I’m generally in favor of stock buybacks, I’m not entirely sure that buying back stocks at a current free cash flow yield of around 3.5% is the best way to do this. I understand that Dollarama wants to buy back as many shares as possible, but perhaps the company should also consider doing a Dutch auction where it could offer an above-market buyout to shareholders who are then asked to deposit their actions. Although this would not allow Dollarama to buy as many shares as it is able to buy on the open market, it would be an option for a certain group of shareholders to simply deposit their shares and take their capital gains.

Investment thesis

Dollarama is not trading at spectacularly cheap levels, but with total net debt of approximately 1.7 times EBITDA (adjusted for lease amortization) and growing revenue both on a comparable basis and in considering expansion plans, Dollarama remains a very interesting idea to watch. The growth rate is very intriguing, and while it looks like it’s buying back shares at quite a high level, it’s better to do it now than after you’ve seen your EBITDA grow another 20% over the past 2-3 coming years.

From an investment perspective, I’m keeping an eye on the company’s options. A P54 for June can be purchased for an option premium of CA$1.10, which would translate to an effective purchase price of CA$52.9, bringing the free cash flow yield closer to 4 % while Dollarama likely continues to buy back shares, further increasing earnings per share.

Dollarama is not a “buy now” stock, but the company’s level of execution has been excellent over the past few years.