Value-oriented reseller dollar tree (DLT 0.59%) will soon have a new CEO. Rick Dreiling, who is currently the chain's executive chairman, will officially take over day-to-day management from Mike Witynski on January 29.
There's no denying he has what it takes. Dreiling, 69, has over 50 years of retail experience, including a seven-year stint as CEO of its main rival, Dollar Tree. general dollar (GD -0.54%). The question is, however, can Dreiling do something that Witynski couldn't do for the underperforming discount? If he can, it's pretty clear where he'll start.
Dollar Tree's Surprising Pain Point
If you're not aware, Dollar Tree is no longer just Dollar Tree. The company acquired Family Dollar in 2015, combining two distinct businesses. Family Dollar is a chain of value-oriented stores that sell merchandise at a variety of price points, while Dollar Tree's ploy from the beginning has been to sell everything it offers for the singular price of $1.
Since then, inflation has forced that value down to $1.25. In fact, in an effort to keep Dollar Tree's assortment attractive enough to keep shoppers coming back and combat the impact of inflation, many Dollar Tree stores now sell a small selection of products for more than $1.25 each (though these items still offer good overall value). However, the Dollar Tree brand has apparently struggled to find a sustainable balance between its rising inventory costs and customers' long-held price expectations.
Interestingly, however, it's not Dollar Tree's arm that's weighing on the parent company's profits. It's Family Dollar, and this despite the chain's pricing flexibility.
The image below tells the story, comparing the similar top lines of the two units and the strangely disparate bottom lines of the two chains.
Data source: Dollar Tree. Chart by author. All dollar amounts are in millions.
Here is perhaps the most relevant comparison of each network's gross margin and operating margin rates.
Data source: Dollar Tree. Chart by author.
For perspective, Dollar General's gross margin rates are typically in the order of 31%, while its net operating margins hover around 9%.
There's an explanation for the strikingly different results produced by Dollar Tree and Family Dollar: the different merchandise mixes sold by the two business segments. About half of Dollar Tree's revenue comes from the sale of consumable goods, such as food, while the other half is driven by the sale of various non-consumable goods. However, about three-quarters of Family Dollar's revenue comes from sales of supplies, where profit margins tend to be thin. The remainder is evenly divided between housewares, clothing, seasonal items, and electronics. These categories tend to be more profitable than food and other regularly consumed items. Family Dollar doesn't sell much of these other merchandise.
Worth a look, but not worth the risk of buying
The question remains: Can Dreiling actually do something about Family Dollar's sales mix that will prevent its already thin margins from plummeting even further? Probably not anytime soon.
To the company's credit, it at least acknowledges the problem. During a third-quarter earnings call in November, CFO Jeff Davis said, "Family Dollar's gross margin declined 100 basis points, primarily due to a shift in product mix and cost inflation."
He continued, however, "We expect to see continued pressure in both segments related to the inflationary cost environment and merchandise mix, as our supply sales are expected to continue to exceed discretionary sales." Neither Davis nor Witynski articulated a specific plan to combat the pressured margins, beyond saying they expect to sell relatively more non-consumable products in the future.
And given the current circumstances, even Dreiling may not have an immediate answer, despite decades of retail experience. As Davis also noted on the call, "The economy continues to put pressure on low- and moderate-income customers, resulting in need-based purchases [of consumables] rather than higher-margin discretionary products."
Bottom line? While investors should give Dollar Tree's new CEO, Rick Dreiling, the benefit of the doubt, that doesn't necessarily mean they should still buy the stock. He'll have to prove he can do what he hasn't yet, which is altering the mix of what Family Dollar regularly sells. Until then, investors looking for a value-oriented retailer with the right mix of products at the right price, sold using the right business model, will want to stick with Dollar General.
James Brumley holds no position in any of the stocks mentioned. The Motley Fool has no position in any of the securities mentioned. The Motley Fool has a disclosure policy.
