Dollarama is the best retail stock in Canada

No really, it is

For those of you who don’t know, my day job is working in the supermarket industry. Specifically, I work as the Grocery Specialist for a small regional grocer. It’s not that hard to figure out which one, but I’ll leave it up to internet sleuths to try and figure it out.

Needless to say, I know the business.

A few years ago after a lackluster result investing in yet another super cheap, yet shitty retailer — Reitmans, if you must know — I swore off the sector forever. Most retailers suffer from abundant competition, zero barriers to entry, terrible margins, a constant struggle with suppliers, high employee turnover, and a whole lot more. Sure, there are good ones, but why bother looking for a diamond in a pile of turds? Especially when there are so many other companies out there.

My feelings didn’t change much when I got back into the industry after a period of time away. I was adding career risk onto the ‘reasons not to invest’ pile. I didn’t want to get into a position where I’d lose my job and part of my investment portfolio if Amazon caused every traditional retailer to go to zero. I’m the first to admit this is perhaps overly conservative, but I’m old and satisfied. I mostly worry about not fucking things up too badly.

But I’ve since changed my tune — at least when it comes to one stock. The more I study Dollarama (TSX:DOL), the more impressed I become. These guys just get it, and they have a unique business model that is poised to grow for a very long time.

So let’s take a closer look at DOL and see what makes it so special.

The genius business model

The average Dollarama store isn’t much to behold. Sure, they’re clean, full, and typically laid out pretty well, but nobody goes into one and is wowed with abundance. At about 10-15,000 square feet they’re not overly big, either.

One of the things most grocers struggle with is how to separate themselves in a world where basically everyone can carry the same products. The Kraft Peanut Butter you buy at Walmart is no different than the Kraft Peanut Butter at Sobeys. But the latter costs $5.99 while the former comes in at some seemingly nonsense number like $4.57. Like any good consumer, you buy it where it’s cheapest.

Dollarama stores don’t run into this problem because they’re so small. If the company finds it’s racing to the bottom on a particular item, it simply doesn’t stock it any longer.

The perfect example are the $2 chips. They went to Frito Lay, told them they’d get exclusive in 500+ stores if they made a product just for them, and the two companies worked out a deal. Dollarama didn’t even try to compete in a segment of the chip business everyone else was in. They essentially reinvented the category to fit their vision.

What this translates to is the best gross margins in the entire Canadian retail industry. While traditional grocers like Sobeys or Loblaws are in the 25-30% range for gross margin — Loblaw is higher than Sobeys/Safeway because it has a greater emphasis on the drug channel — and convenience/gas station chains like Couche-Tard are in the 20% range, thanks to the big emphasis on fuel.

Dollarama’s most recent quarter saw it post 43% gross margins.

The strategy also means Dollarama can deploy its capital at very attractive rates. The average new store pays for itself in an average of just three years. That’s because the company keeps things lean. It rents all of its real estate, buys standard fixtures, and doesn’t waste a whole lot of capital on nonsense.

Look at that storefront. Is that a company that spends a bunch of money on nonsense? It doesn’t even have a bike rack for that poor bastard’s bike.

Expansion potential

Dollarama has done a terrific job increasing both same store sales and opening new stores, giving investors a double whammy of growth. Most other retailers can only marvel at how consistently Dollarama is able to increase its top line.

The company has grown from just one store in 1992 to nearly 1,400 today. Bears argue the days of growth are largely behind Dollarama, but I disagree for a couple important reasons.

Firstly, there’s still plenty of growth potential left in Canada, and for proof you only need to look across the border. There are more than 34,000 dollar stores in the U.S., with another 1,000 or so planned in 2021. There are approximately 10x the number of people in the United States as Canada. That puts Dollarama’s potential at 3,000 to 3,500 stores over the long-term.

One thing U.S. dollar stores have done successfully is migrated into towns of 1,000 to 3,000 people. These towns often have one grocery store, a hardware store, and little else. So citizens do what they’ve always done — pile into the car and go to the nearest city. While there, you can bet they’re visiting Dollarama.

Dollarama has yet to begin cracking this lucrative market. But they will, and it’ll work.

Then there’s Dollarama’s foray into Central America. In 2019 it officially acquired 50.1% of Dollar City, which had more than 200 locations in Colombia, Guatemala, and El Salvador. It plans to triple the number of locations by 2029, mostly focusing on Colombia. There’s massive potential in Central America over the long-term, too.

Share buybacks

What does Dollarama do with all the cash generated from its superior business model? It channels some into expansion, it puts some aside to pay a small dividend, and then it plows the rest into one of the better share buyback programs you’ll ever see.

The company bought back 25% of its shares in the last decade. That’s it. That’s the whole tweet.

The bottom line

I didn’t even touch on some other things, including the founding Rossey family’s big stake in the company. But they don’t matter. Dollarama is an excellent retailer with the ability to grow sales, a business model that should be able to maintain excellent margins, and one of the best long-term share buyback programs I’ve ever seen. It even pays a small growing dividend for the dividend growth folks. It’s expensive, yes, but that really doesn’t matter.

It’s the best retail stock in Canada, and I don’t think anything else really comes close, either.

Disclosure: Nelson owns no shares personally, but he manages money for family members who own DOL.TO.