Dollarama (TSE: DOL) operates dollar stores. It offers a broad range of consumer products and general merchandise for everyday use, in addition to seasonal products.
The company has seen its efficiency improve over the past several years while also creating value for shareholders, thus, making it an interesting stock for investors to consider.
Dollarama’s Efficiency Has Been Improving
Dollarama needs to hold onto a lot of inventory in order to keep its business running. Therefore, the speed at which it can move inventory and convert it into cash is very important in predicting its success.
To measure its efficiency, I will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:
CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding
Dollarama’s cash conversion cycle is 79 days, meaning it takes the company 79 days for it to convert its inventory into cash. In the past several years, this number has trended downwards, indicating that the company’s efficiency has improved.
In addition to the cash conversion cycle, let’s also take a look at Dollarama’s gross margin trend. Ideally, I would like to see a company’s gross margin expand each year. This is, of course, unless its gross margin is already very high, in which case it is acceptable for it to remain flat.
In Dollarama’s case, its gross margin has remained relatively flat since Fiscal 2014, ranging from 47% to 49%. This suggests that the company has a competitive advantage, as competitors aren’t able to chip away at its profitability potential.
Dollarama Creates Value for Shareholders
Great companies often have great management teams that can effectively allocate capital to profitable projects. To get an idea of management’s effectiveness, we can simply look at the numbers. A metric I like to look at is the economic spread, which is defined as follows:
Economic Spread = Cash Return on Invested Capital – Weighted Average Cost of Capital
The idea is very simple; if the cash return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.
For Dollarama, the economic spread is as follows:
Economic Spread = 26.2% – 7%
Economic Spread = 19.2%
As a result, the company is creating value for its shareholders, implying that management is efficiently allocating capital.
Analyst Recommendations
Dollarama has a Moderate Buy consensus rating based on eight Buys, four Holds, and zero Sells assigned in the past three months. The average Dollarama price target of C$78.91 implies 11.3% upside potential.
Final Thoughts
Dollarama is a solid business that has improved its efficiency, and that has created value for shareholders, indicating that the company is well managed. As a result, investors may want to consider taking a closer look at the stock.
