Dollarama (TSX:DOL) is back.
The stock has been picking up traction after its “nasty” 45% peak-to-trough plunge that I called back in January 2018 when the stock was near its all-time high. Stagnant growth and unrealistic expectations were the story of last year, but as we head into the latter part of 2019, with a new growth outlet in Dollarcity in the bag and a now more modest valuation, Dollarama may once again be the go-to defensive growth stock.
Defensive growth stocks are hard to come by, and for that reason, it’s not a mystery as to why shares have commanded a hefty premium for a player in an industry that some may consider boring. At the time of writing, Dollarama is still priced as a hyper-growth stock at 22.42 times next year’s expected earnings with a hefty 20.8 EV/EBITDA.
Growth expectations have undoubtedly been reset with last year’s correction, but investors should proceed with caution after the recent Dollarcity deal. Dollarama’s 50.1% stake in the Latin American discount retailer will be a boon on top-line growth, which has ground to a slowdown in recent years, but it’s not a magical solution to the firm’s issues.
Sure, Dollarama will get its much-needed pop, but I still believe investors should be more focused on domestic comps, because in the end, rising competition in Canada’s discount retail market could more than offset any progress in the firm’s new Latin American interest.
It’s encouraging to hear that Dollarama is dipping its toes in emerging markets and that has many growth investors excited again, but I’m reluctant to pay over 20 times forward earnings until Dollarama is firing on all cylinders — both at home and away.
I’d be much more comfortable with Dollarama’s abilities to replicate its success in a new market if it had found a way to stave off competition in its home market, because like it or not, Dollarama’s “moat erosion” in Canada likely won’t stop until management addresses the issue and takes steps to get more people flowing through its stores. If that means not having cardboard boxes piled up to the ceiling and sprucing up existing locations, then so be it.
Foolish takeaway
While digital efforts and the Dollarcity interest is something to be excited about from a long-term perspective, investors ought to remember that Dollarcity’s contribution to earnings will be minimal (likely accounting for a single-digit percentage of EPS numbers when all is said and done) over the near term.
With that in mind, I’d urge investors to wait for a better entry point at under $40. I think the recent run has overextended itself, and although recent news has been compelling, I think they’ve been exaggerated to the upside.
Stay hungry. Stay Foolish.
