Starboard's Proposals Could Add Value at Dollar Tree

We do not plan to change our $89 per share fair value estimate for no-moat Dollar Tree DLTR after activist investor Starboard's push for a Family Dollar divestiture and the introduction of more price points at Dollar Tree-bannered stores. However, the move, which came as the fund nominated a slate of seven new directors to the board, could add value if the efforts succeed, though we view the high end of Starboard's $120-$150 per share valuation range of outcomes as somewhat optimistic.

With about a 1.7% stake, Starboard called on management to explore "all strategic alternatives … including a sale" of Family Dollar. We have been disappointed with results at the banner, which was bought for $9 billion in 2015, with its lack of differentiation and dependence on competitive urban markets overwhelming Dollar Tree stores' better standing, leading to our no-moat rating. While we believe performance should improve (segment adjusted operating margins expected to rise to around 6% long term versus 4% on average from fiscal 2016-17), we expect the chain will struggle to match Dollar General's high-single-digit margin due in part to the latter's superior locations, often rural areas with little competition. A sale could refocus resources on the better-positioned Dollar Tree banner.

The push for multiple price points at Dollar Tree could also add value, though we are cautious as completely abandoning a relatively low price cap could erode protections against digital rivals. Dollar Tree's low-priced, impulse-friendly assortment leads to small basket sizes with little room for shipping costs. We believe meaningfully higher prices could invite greater competition from Amazon and mass merchandisers. In this vein, we are encouraged that Starboard seeks to keep most products priced at $1, with a few new prices at higher increments (up to roughly $2). Still, while the move could unlock value, it should put a premium on stronger execution in a difficult retail environment.

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