Dollarama Inc.'s rally to record highs on Wednesday might lead you to think that the Canadian discount-store chain dazzled investors with its latest quarterly earnings.
The reality isn't quite as impressive though, which makes this latest rally something to avoid.
Dollarama shares surged 8.4 per cent, to $92.97, after it reported its fiscal fourth-quarter results. Net earnings rose about 8 per cent, to $83-million or $1.17 a share.
That handily topped earnings expectations of $1.10 a share, unleashing much of the enthusiasm for the stock.
So far, so good. But Dollarama fits into a broader trend that has been unfolding in recent weeks: Analysts and companies have been slashing their forecasted earnings to the point where clearing expectations has become a relatively easy matter – and investors are happy to play along.
In the case of Dollarama, estimated earnings were above $1.20 a share at the start of the year, but have been falling steadily ever since.
Over the past week alone estimates fell by 3 cents a share, to the point where clearing the final number of $1.10 wasn't actually such a great accomplishment.
It all sounds rather dismal in fact: Here's a company whose outlook has been deteriorating. And it raises the question: What is everyone so excited about?
There's a lot to like about Dollarama's past performance, of course. If you had bought the stock when it debuted in October, 2009, near the bottom of the bear market, you would be up about 340 per cent after factoring in dividends.
Earnings have grown to $250-million from just $50-million in fiscal 2008, while sales have more than doubled over this period.
Its stores have a clear appeal: They're orderly and well lit, and stocked with just about everything you can think of – all at rock-bottom prices. The stock's initial public offering arrived at a good time, too, when consumers were driven to cut back on expenses following the financial crisis and global recession.
The problem is, Dollarama resembles a commoditized business. The dollar-store concept doesn't create brand loyalty and it fails to offer a retail experience – beyond cheap cheap cheap – that can't be copied by just about anyone, including traditional retailers.
Indeed, the key players now battling it out in the United States – Dollar General Corp., Dollar Tree Inc. and Family Dollar Stores Inc. – are confusingly similar.
The market in Canada is also getting crowded. Dollar Tree has been expanding into Canada, with 180 stores. As well, Wal-Mart Stores Inc. and other retailers are offering many similarly priced items, making dollar stores look less enticing. Even Dollarama's chief executive calls the environment here "very, very competitive."
Dollarama does stand out from its U.S. peers, but mostly in terms of valuation. Its shares trade at nearly 27 times trailing earnings, whereas Dollar Tree's price-to-earnings ratio is below 19 and Family Dollar's P/E ratio is below 16.
The high valuation implies that a lot of good news and strong growth are already built into Dollarama's share price – or, alternatively, that U.S. dollar stores are curiously cheap.
With the global economy improving and the competitive environment heating up, investors' infatuation with dollar stores will soon end. It's better to jump out of this rally, not into it.
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Dollarama fits into a broader trend that has been unfolding in recent weeks: Analysts and companies have been slashing their forecasted earnings to the point where clearing expectations has become a relatively easy matter – and investors are happy to play along.