Are We In a Recession?

Despite 2015 gains in employment, hours worked, and wages per hour, Americans and news media are constantly talking about a recession. It’s true that we’re in the midst of a manufacturing recession, but it’s also true that consumers have more money to spend and they’re spending it, lifting the economy to a level of slow growth.

But reality and perception are two different things. Investors believe that America’s in a recession, and are wondering how to capitalize on it in the stock market.

Recession-Proof Stocks are On Investors’ Minds

In that light, investors are thinking about stocks that reek of budget-consciousness. Stocks like Wal-Mart (WMT). But Wal-Mart is suffering, with profits falling in both 2016 and 2017 (January year-end). The company got too big for its britches and is now scrambling to find a way to grow profits—because without profit growth, there can be no realistic expectation for stock-price growth.

Good recession theory. Wrong stock.

So what’s the right stock? Where can we find a discount retailer with consistent, long-term past and projected growth in earnings and revenue? The answer is Dollar Tree.

A Stock That Has The Goods

Dollar Tree (DLTR) is the nation’s leading operator of discount variety stores. The stores sell basic, everyday merchandise—food, housewares, toys, etc.—enhanced by an assortment of seasonal and closeout products, all at the fixed price of $1.00.

There are three major things that Dollar Tree did in recent years to attract more customers and grow earnings. The company dramatically increased its store count, introduced frozen and refrigerated foods in two-thirds of their stores, and they purchased Family Dollar Stores (FDO), more than doubling the store count to over 13,600 retail stores throughout the U.S. and Canada.

Dollar Tree announced the acquisition of Family Dollar Stores in July 2014, and completed the purchase in July 2015. The acquisition included 222 Deals stores.

When Dollar Tree reports full-year 2016 results (January year-end) around March 1, the results will include the second full quarter in which Dollar Tree and Family Dollar are combined. Costs associated with the transaction put a temporary, one-year halt to Dollar Tree’s long-term earnings growth in fiscal 2016. The process of merging and optimizing the Family Dollar acquisition is expected to take about three years, during which time annual profits are expected to begin growing in fiscal 2017.

In the early stages of the merger, Dollar Tree’s management will necessarily focus on bringing Family Dollar’s merchandising up to snuff. Therefore, the focus is on selling its current merchandise at lower prices, sacrificing margins for faster turnover.

Investors can expect margins to improve as Family Dollar stores make the transition into Dollar Tree Stores. Cost synergies will additionally improve the bottom line.

Dollar Tree has a history of steady earnings and revenue growth, which will be briefly interrupted by a 14% drop in 2016 earnings per share (EPS). When Dollar Tree reports 2016 results near March 1, the market is expecting $2.68 EPS. The good news is that the Wall Street consensus estimate for 2017 reflects 41% EPS growth.

The 2017 price/earnings ratio (P/E) is 21.4, about half the EPS growth rate. The stock does not pay a dividend.

Dollar Tree announced a $2 billion share repurchase authorization in September 2013. The outstanding share count fell from 247 million to 206 million in the four years through its 2015 fiscal year-end. While these numbers will be adjusted for the recent Family Dollar acquisition, it’s helpful to know that corporate management looks favorably upon a strategy of share repurchases, and is willing to put its financial weight behind such efforts.

When two companies combine, the balance sheet and earnings outlook for the new combined company is cloudy. Often, the stock lags until analysts get an accurate feel for where the company is heading financially. However, Dollar Tree’s stock is not remotely lagging, despite the very weak U.S. stock market.

And a Bullish Stock Chart

DLTR reached a new all-time high of 84.22 in March 2015. The stock then traded sideways for five months, fell dramatically with the August-September stock market correction, and recovered at year-end.

Experienced investors will quickly recognize this curiosity: despite the once-again suffering stock market, DLTR’s chart is bullish. 98% of shares are owned by financial institutions, which appear to have zero interest in selling the stock!

There’s strong price support at 75, established both last summer and this winter, so that’s your downside within normal trading activity.

DLTR is a large-cap, consumer discretionary growth stock with a low degree of volatility. The fundamentals are strong and the stock chart is more bullish than most U.S. stocks right now. The stock is in a favored market sector, and investors are looking for recession-proof stocks.

I’d say Dollar Tree fits the bill for a winning stock in 2016!

Happy Investing,

Crista Huff

Chief Analyst, Smart Investing in Turbulent Times