BUSINESS

Dollarama tests Latin American expansion by partnering with local owners

02/05/2013 10:54 EST | Updated 04/07/2013 05:12 EDT
MONTREAL - Dollarama is looking beyond Canada to potentially fuel its long-term growth by partnering with discount chain Dollar City to expand its network of stores in Latin America while cautiously testing a southern expansion.

Under the eight-year agreement announced Tuesday, the Montreal-based company will share its business expertise and allow Dollar City to source from the thousands of products it sells in Canada.

Dollarama (TSX:DOL) won't take on operational responsibilities or make a capital commitment, but could acquire a majority interest in the chain beginning in year seven. Financial terms of such a deal were not disclosed.

The fledgling dollar store chain operates 15 locations in El Salvador and Guatemala but wants to expand in Central America, along with Colombia, Peru and Ecuador.

Dollarama CEO Larry Rossy said it was first introduced by its majority owner Bain Capital to Dollar City's owners in 2009. But he felt the timing wasn't right because it was focused on a large expansion effort.

"We've come a long way from building our organization from within and today I feel that it's an opportunity we couldn't say no to," he said during a conference call.

Dollarama said it doesn't expect the agreement will have an operational or financial impact on the company in the medium-term, but that the Latin American market holds long-term potential.

"It will provide us with a timely window into this market as well as a strategic entry point if in our assessment of the situation in a few years down the road we see a good fit," he told analysts.

Latin America is the world's second-largest emerging market, with a gross domestic product of US$5.6 trillion, 589 million people and stronger growth rates than Canada and the U.S.

Despite the presence of many global retailers and spending patterns similar to North America, the dollar store market is underdeveloped and under served, providing for significant growth potential, Dollarama said.

Rossy said Dollar City will be able to source all but non-confectionery food items from Dollarama. The Canadian chain is willing to make some adjustments to "tropicalize" its offering but won't make special buys for its new partner.

"The broad range of products we source from around the world offer Canadian consumers with tremendous value and we believe that a select subset of these products can offer the same benefits to customers outside Canada."

Chief operating officer Stephane Gonthier said the agreement has been structured to minimize the risk for Dollarama, adding that partnering with a local player who knows the market is a more prudent approach than entering the market on its own.

Dollarama will provide its partner with 20 years of experience it built in operating the business and sourcing products.

"They're going to benefit from much more than what we had in 1992 at which point we were operating 44 locations in Canada."

Dollar City's stores are about half the size of Dollarama's large big box locations, but the expansion should enlarge stores to about the size of the Canadian company's smaller downtown stores.

Gonthier said Dollar City's expansion will go after the emerging middle class in countries where incomes are traditionally lower than in Canada.

The Canadian retailer, which sells products for $3 or less, has been one of the country's big success stories in recent years.

Dollarama currently operates 761 stores across Canada, with a plan to add 80 new locations this year to strengthen its leading market position.

Analysts welcomed the agreement as way to potentially grow the chain.

"Dollarama dips its toe into foreign waters in a low-risk way," said Irene Nattel of RBC Capital Markets.

"Investors should take comfort that this decision appears to have been structured to minimize risk, as Dollarama seeks to establish a longer-term growth opportunity outside of their core Canadian market," she wrote in a report.

Nattel notes that Dollarama's North American peers have not yet exploited the potential in Latin America.

Keith Howlett of Desjardins Capital Markets said Dollarama is ultimately exploring if and how to bring its retail concept to the growing consumer markets in Latin America.

"This opens up potential new avenues of long-term growth," he wrote.

On the Toronto Stock Exchange, Dollarama's shares closed down 18 cents to $59.95 in Tuesday trading.