Will Dollarama Inc. be the next dividend darling?
It may seem like an odd question to ask, given that Canada's largest dollar store retailer has never paid a penny in dividends. What's more, the chain is opening roughly one new store a week, so you'd think all of its cash would be used for expansion.
Yet as Dollarama's profits climb, speculation is growing that the Montreal-based merchant could initiate a dividend as early as this year and still have plenty of money left over to pay down debt and fund its growth.
"Clearly, [Dollarama]is producing far more cash than it needs," CIBC World Markets analyst Perry Caicco said in a recent note. "Hence, it is highly likely that the company will establish a dividend later this year."
It wouldn't be the first dollar store to pay a dividend. In the United States, Family Dollar Stores Inc. initiated a dividend in 1976 and has increased it every year since. Other U.S. rivals, including Dollar General and Dollar Tree , don't pay dividends, but Dollarama boasts higher profit margins and sales per square foot than most U.S. dollar retailers, Mr. Caicco said.
The company isn't saying whether it will initiate a dividend. But it's not ruling it out, either.
"We do have a strong balance sheet. We generate strong cash flows. … We cover our growth investment requirements," Michael Ross, Dollarama's chief financial officer, said on the fiscal fourth-quarter earnings conference call in April.
"So we definitely now have more and more alternatives to maximize shareholder value. And rest assured, we will pick the best strategy as we move forward and communicate that to you when we're ready. And for the time being, we will continue to pay down and reduce our debt and reduce interest charges."
For the fiscal year ended Jan. 30, Dollarama slashed its total debt to $370-million from $526-million, and "they should be able to knock another $100-million off that this year," Mr. Caicco said.
With its debt falling and earnings rising, the company could cover capital expenditures - estimated at $50-million to $60-million in a "heavy-spending year" - and still comfortably afford a dividend yielding 1 per cent to 1.5 per cent, he said.
For the current year, he projects free cash flow - after capital expenditures - of $118.5-million, rising to $142.8-million the following year. A dividend yield of 1.5 per cent based on a $34 stock price would cost about $38.5-million, leaving lots of cash for debt repayment.
Other analysts also see a dividend on the horizon, though not necessarily in 2011.
"We expect that within a couple of years, the company will start to funnel their cash flow into shareholder dividends," Versant Partners analyst Neil Linsdell said in a note.
Dollarama's decision in 2009 to start charging $1.25, $1.50 and $2 for some items has contributed to its "impressive" sales growth and is allowing the company to generate higher margins, he said. Investments in IT systems, including automated checkouts and a new scanning system, are reducing costs and improving supply chain management.
At year-end, the company had 652 retail stores. It expects to open about 50 stores in the current fiscal year.
The stock isn't without risks. The arrival of Dollar Tree, which recently bought Vancouver-based Dollar Giant and plans "significant" growth in Canada, will create stronger demand for sites, push up rents and ultimately lead to head-to-head competition between the chains.
Dollarama "probably has clear sailing on the sales and earnings front for two or three more years until the first impact from [Dollar Tree]is felt," Mr. Caicco said.
Another risk is that Dollarama's majority owner, Bain and Co., "is likely to continue to sell its remaining stake (9.2 million shares) into the market," he said.
On top of that, the company faces higher fuel prices and rising inflation in China, where most of Dollarama's goods are made. But the company says it is dealing with the challenges.
"Let's put it this way - I'm happy we're in the multipriced environment today," chief executive officer Larry Rossy said on the April conference call. "I wouldn't like to be still selling everything at a dollar."