Why Dollarama Is A Broken Growth Story And We See 40%+ Downside Risk

Report Entitled "Hard To Bargain For A Higher Price"

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Executive Summary

Spruce Point believes that Dollarama (TSX: DOL / OTC: OTC:DLMAF or “the Company”) is now a broken growth story that will fail to hit its lofty long-term growth targets, placing its industry-leading margins and valuation multiple at risk of material contraction. As a result, we see ~40% downside risk to C$24.60 per share. Our detailed research report is available on our website . We also encourage all of our readers to follow us on Twitter @sprucepointcap for regular updates. Please review our disclaimer at the bottom of this email.

A discount retailer facing serious fundamental headwinds and pursuing unrealistic growth targets with high likelihood of failure

Rising product prices, progressively saturated markets due to heightened competition, and increasingly stale stores out of touch with Millennials have caused per-store traffic to contract for several years as consumers realize it is no longer a true dollar store. The Company is on pace for its lowest new store count in years despite management’s continued efforts to expand the store base.
Dollarama’s gross and EBITDA margins are inexplicably high relative to peers, and seem too good to be true. Management also claims to have never closed a store for performance reasons. We expect growth and profitability expectations to fall back to reasonable levels as a number of fundamental factors – tougher competition, wage increases, FX, and logistics costs, among others – pressure the business going forward.

Questionable accounting and governance practices cast doubt on management and the underlying health of the business

The Rossy family’s tight control over management has led to the appearance of nepotism, questionable related-party real estate dealings, and is perhaps to blame for Dollarama’s strategic missteps and the increasing staleness of its brand.
Executives are compensated on EBITDA targets, encouraging aggressive accounting and inefficient capital allocation that flatters the income statement. EBITDA-based bonus targets have been adjusted down following misses to allow executives to continue to earn their bonuses.
Management appears to use aggressive FX hedges and an off-balance-sheet relationship with a Central American retail affiliate to boost margins in a non-transparent way. Adding further opacity, management doesn’t disclose store closings or remodels.

Debt load for share repurchases is skewed to short-term borrowings, presenting material refinancing risk as interest rates rapidly rise

Close to C$1.4B of Dollarama’s debt matures within the next 12 quarters. Recent CDOR rate increases have and will continue to drive materially higher interest expenses due to the Company’s dependence on short-term debt, magnifying the financial risks to business overexpansion.
Management has been net sellers of stock at attractive prices while the Company overpays. The CFO owns no shares, creating misaligned incentives.
Dollarama would be better served allocating capital towards refreshing its stores and optimizing its logistics chain rather than repurchasing shares.

Canadian sell-side analysts are blissfully optimistic, and see little risk that Dollarama’s industry-leading valuation will compress

A majority of analysts rate Dollarama a “Buy” without questioning its growth plans or profitability. The sell-side collectively sees 24% upside in DOL.
If we assume that Dollarama will hit its lofty growth targets and aggressively value it as a mature, ex-growth business today, we are hard-pressed to justify a price target much more than C$43.62, or just 11% upside.
Valued at 4x revenue, 16x EBITDA, and 23x EPS, DOL is priced at a 50-60% premium to its discount retailer peers Big Lots ( BIG ), Dollar Tree ( DLTR ), and Dollar General ( DG ). These multiples put DOL in an elite class of retail stocks, and are more reminiscent of what one would expect to see in an established high-fashion retailers (Hermes (RMS FP), Prada (1913 HK), Tiffany ( TIF ), Ferragamo ( OTCPK:SFRGY ) than a low/no-moat dollar store facing fundamental headwinds. In a base-case scenario, we believe shares have ~40% downside risk.

Thank you very much for your continued interest in our investment research.

Disclaimer

This research presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation Dollarama Inc. (“DOL”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.

This research presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in Canadian Dollars, unless specified otherwise.

To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of Dollarama or other insiders of Dollaramathat has not been publicly disclosed by Dollarama. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use.

This report’s estimated fundamental value only represents a best efforts estimate of the potential fundamental valuation of a specific security, and is not expressed as, or implied as, assessments of the quality of a security, a summary of past performance, or an actionable investment strategy for an investor. This is not an offer to sell or a solicitation of an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is not registered as an investment advisor, broker/dealer, or accounting firm.

Disclosure: I am/we are short DLMAF / DOL.TO