DOL (T) $97.04 Stock Rating: Outperform (Unchanged) Target: $105.00 (Was $104.00) Risk Rating: Average (Unchanged) Est. Total Return: 8.6% Stock Data: 52-week High-Low (Canada) Bloomberg $98.94 - $66.32 DOL CN Forecasts : Fiscal year-end: January F2016A F2017E F2018E Revenue (mln) $2,650.3 $2,936.5 $3,232.8 EBITDA (mln) $597.5 $652.4 $714.1 EBIT (mln) $549.4 $595.2 $649.5 Net Income (mln) $385.1 $414.7 $448.1 Diluted EPS $3.01 $3.44 $3.85 Dividends/Share $0.36 $0.39 $0.45 P/E 32.2x 28.2x 25.2x EV/EBITDA 21.7x 19.9x 18.1x Quarterly EPS: F2016A F2017E F2018E Q1 $0.50 $0.68 $0.75 Q2 $0.74 $0.82 $0.91 Q3 $0.78 $0.86 $0.97 Q4 $1.00 $1.08 $1.22 Financial Data: Shares Outstanding (diluted, mln) 123.2 Market Capitalization (mln) $11,950.7 Dividend Yield 0.4% Net Debt (mln) $1,009.2 Net Debt/Total Capitalization (B/S) 75.5% Book Value per Share $2.66 Price/Book Ratio 36.5x Industry Rating: Underweight (NBF Economics & Strategy Group) August 19, 2016 Dollarama Inc. Q2 F2017 Preview The NBF Daily Bulletin Merchandising and Consumer Products (1) Growth expected to continue (2) A deeper look at valuation HIGHLIGHTS We project Q2/F17 EPS of $0.82 vs. cons. at $0.84; last year was $0.74 (1) We project same store sales growth (sssg) of 5.7%, lower than 7.9% last year; last quarter was 6.6%. Our sssg projection is based on basket growth of 3.4% y/y and transaction growth of 2.3% y/y. Management indicated during the prior conference call that basket growth benefitted from an increased demand, in part, for higher price point items. (2) We project sales of $723 mln vs. consensus at $728 mln; last year was $653 mln. We project a gross margin rate of 36.9%, lower by 150 bps y/y largely due to FX; pricing and fixed cost leverage are expected to serve as partial positive offsets. We forecast an SG&A rate of 15.2%, lower by 70 bps y/y. We project EBITDA of $157 mln vs. consensus at $162 mln; last year was $147 mln. We project an EBITDA margin rate of 21.7%, lower by 80 bps y/y. (3) Dollarama reports results on Sept. 1, 2016 before market open. The conference call is scheduled for 10:30 a.m. EDT; the dial-in details are (866) 223-7781 or (514) 392-1478. Other thoughts and comments (1) We forecast a solid quarter given strong sales growth. Notwithstanding, y/y comparisons are becoming more difficult because of temporary margin/pricing benefits implemented last year. Recall that management has spoken specifically about the expectations of lower gross margins in F2017 relative to F2016. We note that management also updated its SG&A rate guidance favourably last quarter, which should serve as a partial positive offset. (2) Recall that Dollarama plans to introduce higher price points ($3.50 and $4.00) beginning in H2/F17. The company has not set specific targets related to higher priced merchandise, but does not expect significant impact in F2017 given a limited initial offering. Over time, we believe that higher price points will support same store sales growth. Valuation is supported by the growth profile (1) Dollarama trades at 19.5x NTM EBITDA and 27.6x NTM EPS. This is the highest valuation level in our coverage universe. Not surprisingly, valuation is a key concern for most investors. (2) We present three DCF scenarios which reflect share values based on varied growth outlooks. In our base case scenario (WACC at 7.5%; terminal growth at 3.0%), we impute a DCF valuation of $105; similarly our low scenario imputes a valuation of $89 and our high scenario imputes a valuation of $112. (3) We believe that Dollarama s valuation is supported at the current level; however, it remains very sensitive to the growth outlook. Details are in the note. Maintain Outperform rating; Price target is $105 from $104 We value Dollarama at 26.5x our blended F18/F19 EPS. Company Profile: Dollarama is a Canadian retailer operating in the high-value, small-format retail segment. The company was founded in 1992. Dollarama sells a variety of general merchandise and consumable products. Stock Performance 100 75 10.0 7.5 Vishal Shreedhar - (416) 869-7930 vishal.shreedhar@nbc.ca Price ($/share) 50 25 5.0 2.5 Volume (millions) Associate: Ryan Li - (416) 869-6767 ryan.li@nbc.ca 0 0.0 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Source: Thomson, NBF
Page 2 Q2 F2017 Preview: (1) Growth expected to continue (2) A deeper look at valuation Quarter Preview Dollarama reports results on Sept. 1, 2016 before market open. The conference call is scheduled for 10:30 a.m. EDT; the dial-in details are (866) 223-7781 or (514) 392-1478. We project Q2/F17 EPS of $0.82 versus consensus at $0.84; last year was $0.74. EPS growth of 11% y/y is largely predicated on solid sales performance, SG&A leverage and share repurchases. EPS growth is expected to slow sequentially. This is because Dollarama will lap heightened gross margins associated with management s prior plan to increase merchandise prices in advance of favourable FX hedges fading off. Management has spoken specifically about the expectations of lower gross margins in F2017 relative to F2016. We forecast continued strong same store sales growth (sssg) of 5.7%, below last year at 7.9% and last quarter at 6.6%. Our sssg projection is based on basket growth of 3.4% y/y and transaction growth of 2.3% y/y. We project total sales of $723 million versus consensus at $728 million; last year was $653 million. We project EBITDA of $157 million, slightly lower than consensus at $162 million; last year was $147 million. Details relating to our Q2/F17 forecasts are in Figure 5. Thoughts and Comments Are investor expectations reasonable? Dollarama trades at 19.5x NTM EBITDA and 27.6x NTM EPS. This is the highest valuation level in our coverage universe. Not surprisingly, valuation is a key concern for most investors. We believe Dollarama s outlook depends on the free cash flow outlook. o We believe that investors are looking beyond management s plans for 1,400 stores in Canada and gross margins of ~36%-37% (NBF is slightly above that range). For example, if we were only to reflect management s articulated plan, we impute a one-year target price of ~$85 (using a DCF). o In our view, it s likely that Dollarama will be able to grow substantially beyond management s current plan. We present three DCF scenarios which reflect share values based on varied growth outlooks. In our base case, we utilize a weighted average cost of capital (WACC) of 7.5% and we project medium-term free cash flow growth (5.6% CAGR) to taper moderately towards the terminal growth rate of 3.0%. The result is a DCF valuation of ~$105; similarly our low scenario imputes a valuation of $89 and our high scenario imputes a valuation of $112. We believe that Dollarama s valuation is supported at the current level; however, we highlight that it remains very sensitive to the growth outlook. Please contact us if you would like to review our valuation scenario analysis. The balance between pricing and FX: Recall that last quarter, management reiterated its F2017 gross margin rate target of 37%-38%. In F2017, y/y gross margin rate contraction is expected due to heightened gross margins in the prior year and expected headwinds from FX. Our gross margin rate change cadence from Q2/F17 to Q1/F18 is as follows: -150 bps y/y, -170 bps y/y, -140 bps y/y and -50 bps y/y.
Page 3 o Guidance is oftentimes conservative: We note that management has historically been too conservative with guidance. Our F2017 estimates are at the high end of management guidance. For example, over the last four years (including F2016), management initially guided to a fiscal year gross margin rate of 36%-37%, but subsequently delivered higher in all but F2015, where it delivered 36.9%. In addition, in recent quarters, management raised initial gross margin guidance (Q4/F16) and issued favourable revisions to its SG&A rate guidance (Q1/F17). Share repurchases continue: During Q2/F17, we estimate that Dollarama repurchased ~2 million shares at a cost of $184 million. o Recall that in June 2016, Dollarama renewed its NCIB program which allows for the repurchase of six million shares through to June 2017. Of the shares repurchased during Q2/F17, we estimate that only ~437,000 shares were allocated to the new NCIB program. For the new NCIB program, we currently reflect 60%-70% utilization (similar to our forecasts indicated last quarter), predicated on the company maintaining an adjusted net debt to EBITDAR ratio at or below 3.0x. Notwithstanding, if FCF accelerates during the next several quarters, it is feasible for Dollarama to fully utilize the current NCIB. We estimate that if Dollarama were to repurchase the full six million shares allotted, relative to our current repurchase forecast, the incremental EPS benefit would be ~$0.02. Rating & Recommendation We reiterate our Outperform rating. Our price target increases to $105 from $104 largely due to a slight increase in our EPS estimates. We value Dollarama at 26.5x our blended F18/F19 EPS. Dollarama currently trades at 27.6x our NTM EPS versus its historical average of 22.5x. In our view, Dollarama is a well-managed retailer as demonstrated by its strong growth and high ROIC, which have been realized despite challenging market conditions. We believe that Dollarama has potential to deliver above-average growth over several years supported by same store sales growth, network expansion and increased operational efficiency. Furthermore, we believe that the Canadian dollar store market has potential for growth given a relatively low store penetration rate and increasing demand for value from consumers. Charts & Tables Figure 1: Estimate Revisions Our estimates remain largely unchanged; the modest change is due to an altered share repurchase cadence and slight sales growth adjustments. F2017 F2018 Before After Before After Revenue 2,933.9 2,936.5 3,224.4 3,232.8 EBITDA 651.9 652.4 712.2 714.1 EPS $3.42 $3.44 $3.84 $3.85 Quarterly EPS Summary ($) Q1 $0.68 $0.68 $0.75 $0.75 Q2 $0.81 $0.82 $0.91 $0.91 Q3 $0.86 $0.86 $0.97 $0.97 Q4 $1.08 $1.08 $1.21 $1.22 Note: In $ millions, unless per share data.
Page 4 Figure 2: Credit Metrics Dollarama (Consolidated): Q2/F16 Q3/F16 Q4/F16 Q1/F17 F2017E F2018E Net Debt/EBITDA 1.2x 1.3x 1.4x 1.6x 1.8x 1.8x Adj. Net Debt/EBITDAR 2.7x 2.7x 2.8x 2.9x 3.0x 3.0x Net Debt/Capital 46.3% 53.7% 65.0% 75.5% 82.9% 86.7% EBITDA/Interest 25.5x 27.3x 27.9x 27.8x 22.9x 19.1x Note: Operating leases have been capitalized at 8.0x. Figure 3: Quarterly Share Repurchase History During the quarter, we estimate that Dollarama repurchased ~2.0 million shares at a cost of ~$184 million. Share repurchase momentum is expected to continue. We believe that Dollarama will utilize ~60%-70% of its current NCIB program which allows for the repurchase of six million shares through to June 2017; our projection is predicated on the company maintaining an adjusted net debt to EBITDAR ratio at or below 3.0x. Notwithstanding, higher-than-expected free cash flow could allow the company to complete its NCIB program without increasing leverage. 350 300 250 200 150 100 50 0 Q2/F14 Q3/F14 Q4/F14 Q1/F15 Q2/F15 Q3/F15 Q4/F15 Q1/F16 Q2/F16 Q3/F16 Q4/F16 Q1/F17 Q2/F17E Figure 4: Free Cash Flow (FCF) Projections - Various Growth Scenarios We present three DCF scenarios which reflect share values based on varied medium-term growth outlooks. For each case, we use a weighted average cost of capital (WACC) of 7.5% and a terminal growth rate of 3.0%. (1) Low Case: Medium-term FCF CAGR is 4.1%; FCF growth tapers quickly to the terminal growth rate; DCF valuation is $89. (2) Base Case: Medium-term FCF CAGR is 5.6%; FCF growth tapers moderately to the terminal growth rate; DCF valuation is $105. (3) High Case: Medium-term FCF CAGR is 6.2%; FCF growth tapers slowly to the terminal growth rate; DCF valuation is $112. Free Cash Flow Projections (Short Term, Medium Term) 1,200 1,000 Historical Short Term (5 years) Medium Term (9 years) 800 600 400 200 Low Case Base Case High Case 4.1% CAGR 5.6% CAGR 6.2% CAGR 0 Low Case Base Case High Case Note: Free Cash Flow (FCF) to the Firm is denoted in $ millions. Analysis assumes growth beyond the 1,400 store threshold indicated by management.
Page 5 Figure 5: Q2 F2017 Financial Summary Q2 Q2 F2017 F2016A Cons. NBF Est. Comments Same Store Sales Growth 7.9% 5.7% Our sssg forecast reflects basket growth of 3.4% y/y and traffic growth of 2.3% y/y. We anticipate that traffic growth momentum will continue from recent quarters (above 2% since Q4/F16). Continued basket growth is expected to reflect continued penetration of products priced higher than $1.25. Revenue 653.3 727.9 723.2 We forecast revenue growth of 10.7% y/y largely due to continued square footage growth and strong sssg. We forecast square footage growth of 6.5% y/y supported by our expectation of 15 net new store openings in Q2/F17. Cost of Sales 402.7 456.6 Gross Margin 250.6 266.5 We forecast gross margin (dollar) growth of 6.4% y/y due mostly to sales growth and gross margin contraction, largely related to the impact of F/X as previously telegraphed by management. We project a gross margin rate of 36.9% or 150 bps lower y/y; scaling benefits of strong sssg, lower logistics costs, and higher selling prices are expected to serve as partial positive offsets. SG&A 103.7 109.8 We forecast an SG&A rate of 15.2%, lower by 70 bps y/y, reflecting continued store labour productivity improvements and the positive scaling impact of strong sssg. Our annual SG&A rate is in line with management's target of 15.5%-16.0%. EBITDA 146.9 161.5 156.8 We forecast an EBITDA margin of 21.7%, lower by 80 bps y/y. Amortization 11.8 14.0 EBIT 135.1 142.8 Interest Expense 4.4 6.8 EBT 130.7 136.0 Tax 35.2 36.5 We forecast an effective tax rate of 26.8%, in line with management's view of the statutory tax rate. Net Income 95.5 99.6 EPS $0.74 $0.84 $0.82 The company repurchased ~2.0 mln shares for ~$184 million during Q2/F17. Note: Income statement data (except per share data, or otherwise indicated) is noted in $ millions. Source: Company Reports, Thomson, NBF
Page 6 DISCLOSURES: Ratings And What They Mean: PRIMARY STOCK RATING: NBF has a three-tiered rating system that is relative to the coverage universe of the particular analyst. Here is a brief description of each: Outperform The stock is expected to outperform the analyst s coverage universe over the next 12 months; Sector Perform The stock is projected to perform in line with the sector over the next 12 months; Underperform The stock is expected to underperform the sector over the next 12 months. SECONDARY STOCK RATING: Under Review Our analyst has withdrawn the rating because of insufficient information and is awaiting more information and/or clarification; Tender Our analyst is recommending that investors tender to a specific offering for the company s stock; Restricted Because of ongoing investment banking transactions or because of other circumstances, NBF policy and/or laws or regulations preclude our analyst from rating a company s stock. INDUSTRY RATING: NBF has an Industry Weighting system that reflects the view of our Economics & Strategy Group, using its sector rotation strategy. The three-tiered system rates industries as Overweight, Market Weight and Underweight, depending on the sector s projected performance against broader market averages over the next 12 months. RISK RATING: NBF utilizes a four-tiered risk rating system, Below Average, Average, Above Average and Speculative. The system attempts to evaluate risk against the overall market. In addition to sector-specific criteria, analysts also utilize quantitative and qualitative criteria in choosing a rating. The criteria include predictability of financial results, share price volatility, credit ratings, share liquidity and balance sheet quality. General National Bank Financial (NBF) is an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on Canadian stock exchanges. 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(2,3,4,5,6,7) 2 National Bank Financial Inc. has acted as an underwriter with respect to this issuer within the past 12 months. 3 National Bank Financial Inc. has provided investment banking services for this issuer within the past 12 months. 4 National Bank Financial Inc. or an affiliate has managed or co-managed a public offering of securities with respect to this issuer within the past 12 months. 5 National Bank Financial Inc. or an affiliate has received compensation for investment banking services from this issuer within the past 12 months. 6 National Bank Financial Inc. or an affiliate has a non-investment banking services related relationship during the past 12 months. 7 The issuer is a client, or was a client, of National Bank Financial Inc. or an affiliate within the past 12 months.