July 10 (Bloomberg) -- Dollarama Inc. said its overseas experiment is progressing better than expected, providing a potential avenue for expansion as the dollar-store chain’s growth slows in Canada.
Dollarama, the best-performing discount retailer over the past three years, struck a deal in February 2013 to supply its products and operational expertise to Dollar City, which has about 15 stores in El Salvador and is looking to expand in Central America. Dollarama receives a handling fee and has an option to buy control of the company beginning in February 2019.
“We’re planting seeds early on, making sure that we get it right,” Michael Ross, 54, Dollarama’s chief financial officer said in a phone interview last week from Montreal, where the company is based. “If we can replicate Dollarama outside of Canada and open up on the international side that obviously will be great.”
There’s still a lot “to be proven,” including whether Dollar City can expand profitably and build an efficient logistics system to allow for store growth in other countries such as Costa Rica and Panama, Ross said.
A move outside Canada would provide Dollarama with growth opportunities as dollar stores reach saturation in Canada and competition heats up with the debut of Chesapeake, Virginia-based Dollar Tree Inc. in the country in 2010.
Same-store sales growth has averaged 6 percent since Dollarama’s initial public offering in 2009 and the company’s not expecting that to last, Ross said.
“We don’t think we can sustain that in the future,” Ross said. “We’d be disappointed if we could not sustain four percent,” he said, reiterating comments he made in an April conference call.
Dollarama same-store sales growth fell to to 3.8 percent in fiscal 2014 from 6.5 percent in 2013 and 5.4 percent in 2012, according to data compiled by Bloomberg News. They registered 3.3 percent in the first quarter.
The stock surged 177 percent in the three years through yesterday, the biggest advance among 16 mass merchants tracked by Bloomberg, including Wal-Mart Stores Inc. and Dollar Tree. The stock has 14 buy ratings, two holds and one sell according to ratings compiled by Bloomberg.
The shares closed little changed at C$91.12 in Toronto, up more than five fold from Dollarama’s C$17.50 initial public offering. Splitting the stock is a possibility, Ross said.
“We’ll see but certainly that’s crossing our minds,” he said.
While international expansion is a long-term prospect Dollarama’s short-term sights are firmly set on Canada and establishing about 1,200 stores throughout the country, Ross said. The company plans to open 70 to 80 new stores this year to add to 900 or so they already have in the market.
“We still have four or five years of good runway here in Canada so that’s our prime focus,” Ross said.
Canada has capacity for 2,400 dollar stores, Neil Linsdell, a Montreal-based analyst with Industrial Alliance Securities wrote in a June 30 note.
Dollarama’s stake in Dollar City “could drive several decades of international expansion,”he wrote in the same note.
“There’s likely a higher proportion of the population that could fall into the sweet spot for Dollar City’s product offerings,” he said in an e-mail.
The Canadian dollar’s 1.5 percent decline against the U.S. dollar over the past year is “definitely not positive” but Dollarama adjusts 25 to 30 percent of its items each year to maintain margins of 36 percent to 37 percent, Ross said.
“If the cost pressure is too high on certain items we can change, discontinue those items, repackage them,” he said. Dollarama’s multi-price point strategy -- items range from C$1 to C$3 -- gives it more flexibility to deal with cost pressures, he said.
Dollarama earned about 62 percent of its sales from items priced higher than $1.00 in the first quarter, compared with 58 percent in the same quarter a year ago, according to company documents.
There might be a point where prices get too high for the dollar store and Dollarama will lose the low-price advantage it has over other discount retailers, Kathleen Wong, an analyst for Veritas Investment Research Corp. in Toronto, said in a phone interview. Wong has a sell on the stock because she said the current stock price isn’t possible with her predicted same-store sales growth.
“If they are approaching a point of saturation, going forward, the same-store sales growth may not be that sustainable,” Wong said. “The company expects to have 4 to 5 percent same store-sales growth in the long-term but my number is showing 4 percent is more reasonable. If I do 4 percent same-store sales growth I can only get to $84.00 intrinsic value,” less than yesterday’s closing of C$91.17.
Dollarama is also hedging the Canadian dollar six months ahead to protect itself from the a loss in its purchasing power, Ross said. The company imports about 53 percent of its goods from 25 different countries, with China its main trading partner.
“That allows them to reverse engineer back into the gross margin we’re trying to maintain which is between 36 and 37 percent,” Ross said.
Dollarama’s dividend yields about 0.7 percent, compared with 2 percent for its peers in the S&P/TSX Consumer Discretionary Index, according to data compiled by Bloomberg.
“There’s no rush to increase the payout or the yield,” he said. “Right now we prefer the share buy-back approach in that it’s much more accretive.”
To contact the reporter on this story: Jaime Myslik in Toronto at email@example.com
To contact the editors responsible for this story: Nick Turner at firstname.lastname@example.org Jacqueline Thorpe