The Best Food Retail Stock Is...Dollar Tree?

The food and grocery sector's struggles and challenges have been made clear throughout 2017. But investors shouldn't shy away from investing in the space and may want to consider an investment in Dollar Tree, Inc. DLTR as the best way to gain exposure to food retailers.

The Analyst

Goldman Sachs' Christopher Prykull initiated coverage of Dollar Tree's stock with a $106 price target and named the stock as top pick in the space.

The Thesis

Dollar Tree boasts several key advantage that makes it "more immune" to online threats -- convenient locations with a focus on value, Prykull said in an industry-wide research note. Specifically, Dollar Tree's core market of lower-income families are less likely to pay delivery fees for food orders and see the retailer as a "destination for fill-in trips as opposed to stock-up trips."

Aside from core advantages over rivals, the dollar store company's free cash flow growth profile is underappreciated by the Street, the analyst said. The company will likely generate $1.2 billion of free cash flow in 2018, which will then be boosted to $1.4 billion in 2019 with further growth beyond the next two years as one-time integration costs from its acquisition of Family Dollar. As such, management will likely re-introduce a stock buyback program in 2019 and simultaneously generate a double-digit earnings per share growth rate.

Dollar Tree's annual synergies target of $300 million from the acquisition may play out to be larger as the company's targets implies just 1.7 percent of the combined company's pro forma sales. But other deals of similar sizes resulted in the combined company achieving a synergies saving rate as high as 2.8 percent of combined sales which implies the potential for upside to Dollar Tree's targets.

Sprouts And Supervalu Initiated At Sell

At the other end of the spectrum, Prykull initiated coverage of Sprouts Farmers Market Inc SFM and SUPERVALU INC. SVU with Sell ratings.

The organic grocery chain's margins appear to be unsustainable in the highly competitive grocery market which in turn calls into question the stock's premium valuation. The bearish view on Supervalu is attributed to a "challenged" end market, headwinds from retail competition and "waning" revenue from the transition service agreement .

Price Action

• Shares of Dollar Tree have gained 21 percent since the start of 2017.
• Shares of Sprouts Farmers are higher by 7 percent since the start of 2017.
• Shares of Supervalu are lower by 55 percent since the start of 2017.

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