Dollar Tree Won’t Be Trading At a Discount For Much Longer

Key Points

• Shares of Dollar Tree experienced a viscous sell-off through much of September. 
• However, they appear to have put in a low and have been rallying for the past fortnight. 
• Goldman Sachs sees additional upside from here, and further gains are expected. 

Despite hitting all-time highs last year as one of the best stocks to own during a recession, Dollar Tree Inc NASDAQ: DLTR has been on the defensive since the summer. Until this past August, their shares had held an almost unmatched track record of rallying before, during, and after the pandemic. But a poor end to the summer saw them drop more than 30% into October, which put them back trading at 2017 levels. 

While you could argue shares had been consolidating for the first half of this year, they were starting to run out of steam by the second quarter, and August's earnings report confirmed this. Despite topping expectations on the headline numbers, Dollar Tree's once stellar margins plunged, forcing management to issue forward guidance below what analysts had expected. 

Sharp Sell-off means Opportunity 

There's nothing quite like a sudden congregation of dark clouds on the horizon to make even the most bullish investors run for cover, and so it was that many rushed to lock in gains and take their money off the table. For context on just how aggressive that round of selling was, consider this: the stock's relative strength index, a measurement of how overbought or oversold it is, was in the low teens until the last week of September, which indicates it was extremely oversold. However, since hitting a low on October 2, Dollar Tree shares have steadily risen and are suddenly up 12%. 

It's starting to look like the doom and gloom scenario that spooked investors was a bit overdone, and if that's the case, readers can expect a sharp recovery in Dollar Tree stock. At least, this was the message from the team at Goldman Sachs yesterday, who spoke bullishly to the company's outlook as part of their upgrade on Dollar Tree shares from Neutral to a Buy rating. 

They see Dollar Tree continuing to capture market share, supported by improving traffic trends and a sticky customer base. Another key driver they see supporting the long side is the improving discretionary cash flow outlook for lower and middle-income consumers heading into next year. Together, you've got the perfect store for a discount retailer like Dollar Tree, so the company's earnings are expected to exceed the current estimates. 

The squeezed margins, which did so much damage over the summer, will be supported by the additional revenue growth and a drop in expenses due to factors like lower shipping costs, for example. Goldman sees them delivering an annual earnings growth rate of 19% through 2026, putting them ahead of their peer group. 

20% Upside for Dollar Tree Stock 

A fresh price target of $137, implying an upside of about 20% from where shares closed on Tuesday, should be very doable, as this would only have them back trading at the lower end of their pre-selloff range. If shares were able to tread water and consolidate there, they'd form a solid line of support for a further recovery towards the $150 mark. 

While the momentum is currently with the bulls, much will depend on Dollar Tree's next earnings report when it comes to the stock's broader trend into and through 2024. This is due in the second half of November, and analysts will be watching closely to see a recovery in the company's margins. They'll also want to see an uptick in revenue, which has struggled so far this year to top the record $7.7 billion that was reported in January. Considering shares are currently trading at 2017 levels when Dollar Tree's revenue was two-thirds of what it is today, you can't help feeling that the risk/reward is pretty attractive right now. 

With Goldman Sachs now in the bull's corner, we can expect their shares to continue rallying into November as hype builds around the potential for a comeback. If you're feeling brave, this is an interesting time to consider getting involved, as you'd have the option to take some gains off the table before the actual report while still holding some through it in case there's a massive upside surprise.