Spruce Point Capital Releases a Strong Sell Forensic Research Opinion on Dollarama Inc. (Toronto: DOL, DLMAF:OTC)
NEW YORK, Oct. 31, 2018 /PRNewswire/ -- Report entitled "Hard To Bargain For A Higher Price" outlines how Dollarama faces ~40% downside risk to C$24.60 per share because of serious fundamental headwinds, unachievable growth targets, and questionable governance.
- Declining Fundamentals And Unsustainable Margins: Faced with years of negative average traffic growth and an increasingly saturated market, Dollarama is driving comparable store sales growth by abandoning its roots as a dollar store and selling items at progressively higher price points– a move which, while supporting margins, has angered its discount-driven customer base and put further pressure on store traffic. Dollarama has also benefited from a benign competitive environment and various financial and accounting maneuvers which have kept margins over twice the industry average. However, we believe that avenues for further cost-cutting have largely been exhausted, and that Dollarama now faces a wave of cost increases from tariffs, wage hikes, and transportation and marketing-related costs – in addition to very significant FX risks. Additionally, industry competition is poised to intensify as competitors look to increase store counts and as new competitors enter the market. Barring further financial creativity by management, we expect margins to retreat towards peer levels.
- Growth Plan Appears Unrealistic: At the time of its IPO in 2009, Dollarama cited a long-term store target of 900 – up from 585 in 2009. Management has since revised this number upwards multiple times: first to 1,200, then to 1,400, and most recently to 1,700. Our competitive benchmarking analysis shows that this target is likely unrealistic, and that the market is already bordering on oversaturation. Dollarama's FY '19 store opening pace has thus far been its slowest in years.
- Capital Allocation And Refinancing Risk: Rather than refresh its increasingly stale store base or optimize its logistics chain, Dollarama management has historically elected to allocate capital toward buying back stock – even at expensive prices – with the support of short-term debt. This activity has helped to support the stock's inflated multiple and thus to enrich Dollarama executives, who have consistently sold into share repurchases. Importantly, close to C$1B of Dollarama's debt matures over the next two years. Recent CDOR rate increases will drive materially higher interest expenses, magnifying the financial risks posed by overexpansion.
- Questionable Accounting And Governance Practices: Management pitches its currency hedging as a pure offset to CAD depreciation, but it has been a material profit center for Dollarama through the last several years. Dollarama's earnings quality also shows signs of weakness, highlighted by amortization schedule mismatches and capex well in excess of depreciation. The Rossy family launched Dollarama from its legacy retail chain in 1992 and owns significant real estate assets that are employed by the enterprise. This may have played a role in management's recent decision to acquire Dollarama's existing Montreal distribution center from the Rossys rather than open a second distribution facility in western Canada, as have most peers. Acquiring related-party real estate not only lines the pockets of the founding family, but also allows Dollarama to shift rent expenses out of the operating line, thus boosting EBITDA closer to management's bonus targets.
- Dollarama's Irrational Valuation Multiple Could Materially Contract: DOL currently trades at a ~50% premium to peers and carries among the highest multiples of any global retailer. Higher only are the valuations of crème de la crème global fashion brands – Hermes, Prada, Ferragamo, Tiffany & Co. Such lofty multiples are wholly inappropriate for a discount retailer with serious near-to-medium-term business risks. Analyst estimates are not sufficiently skeptical of management's growth targets in light of these concerns. Even if Dollarama executes its growth plan perfectly, maintains its world-leading margin, and retains a hefty valuation premium to its peers, the stock is at best fairly valued at ~C$43, leaving it with little to no upside at current levels. Under more reasonable assumptions which still give Dollarama credit for future store growth and above-average margins, the stock is worth ~C$25, about 45% below current levels.
The research report can be found on our website at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
Spruce Point Capital has a short position in Dollarama Inc. (TSX: DOL, DLMAF:OTC) and stands to benefit if its share price falls.
About Spruce Point Capital
Spruce Point Capital Management, LLC, is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities.
