Money Really Does Grow on (Dollar) Trees

After last quarter, it looked like money did not grow on trees. This quarter tells an entirely different story.

Dollar Tree (NASDAQ: DLTR) reported much better than expected earnings this morning,. and shares are up as of the time of this article on the better than expected earnings, as well as raised guidance.

The Chesapeake, VA-based dollar store reported third quarter earnings of 87 cents per share on $1.60 billion in revenues. Wall Street was looking for 83 cents per share on $1.58 billion in revenues. In addition to the earnings beat, the company raised 2011 guidance. It said it now expects to earn $3.94-$4.01 per share, versus a prior view of $3.82-$3.95 per share. Wall Street expects full year earnings of $3.99 per share.

"I am very pleased with the Company's performance in the third quarter," said President and CEO Bob Sasser. “Dollar Tree achieved double-digit growth in sales, operating margin and earnings per share against a very strong performance last year. Our merchandising and store teams continue to deliver exciting products at great values and a fun, friendly, convenient shopping experience for our customers.”

Dollar Tree was able to grow earnings 13% quarter-over-quarter and revenues 3.8% quarter-over-quarter. Just as equally impressive was the year-over-year growth, with earnings growing 19.2%, while revenue jumped 11.9%. The company saw operating margins rise 40 basis points to 10.3%, as the company opened 98 stores, expanded or relocated 24, and closed 5 others during the quarter.

The company also bought back 3.3 million shares under an existing buyback plan. It still has $1.5 billion under the program, which should help support the share price going forward.

Dollar stores have been among the hottest investments in 2011, as names like Bill Ackman, Warren Buffett, and Nelson Peltz have significant stakes in the space. Ackman and Peltz are in Family Dollar (NYSE: FDO), while Buffett is in Dollar General (NYSE: DG). Consumer spending has kept pace, but we are increasingly seeing an "hour glass" economy. The super wealthy are doing well, and the middle income consumer is being pushed down to the lower class. As this demographic change continues to happen, money is flowing to the dollar store space. This comes as the expense of Wal-Mart (NYSE: WMT) and perhaps even Target (NYSE: TGT).

After last quarters' earnings miss, the optimism was removed a little. This quarter has changed that mindset as we head into 2012. Shares are trading at 16 times projected 2012 earnings, and if the middle income consumer continues to get squeezed, those estimates could prove conservative.

This quarter proves that money really does grow on trees. You just have to know which tree to look for.

ACTION ITEMS:

Bullish:
Traders who believe that the U.S. economy will slow and consumers will flock to dollar stores might want to consider the following trades:

• Consider any of the names mentioned above. Ackman believes Family Dollar is worth $70, and Buffett moved into the best in class, Dollar General.

Bearish:
This line of thinking is bearish for the U.S. economy. It's not encouraging to see consumers trade down. It generally means a recession is happening or is about to happen.

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