Where Are the Discount Retail Bargains?
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Where should investors look for bargains among discount retailers?
Dollar stores have been a darling for investors and consumers alike in U.S. markets. They present a challenge to big box retailers, which seem to have fallen behind. Should investors continue to flock to them, or are other discount retail stocks better priced to sell? Does Wal-Mart (NYSE: WMT) or any other discount retailer present a better opportunity based on international growth opportunities?
Discount Retailers in Canada
Dollarama (DOL.TO) dominates the Canadian discount retail market. It outnumbers its competitors Wal-Mart and Target (NYSE: TGT) in Canada with over 700 stores. In fact, Dollarama has more Canadian locations than all of its discount competitors. CIBC World Markets analyst Perry Caicco wrote, “While retailers such as Canadian Tire Corp. face increased competition from Target’s entry into Canada in 2013, the only firm with the potential to take on Dollarama is U.S. chain Dollar Tree (NASDAQ: DLTR), which is at least five years from having the scale to compete.”
Dollar Tree is expecting to expand in Canada by adding stores and building an infrastructure to support the national network. It acquired Dollar Giant sores in 2010 for $52 million in cash to have stores across 85 locations in Canada. It plans to have 1,000 stores across the country.
According to a Bloomberg survey, respondents expect the Canadian market to grow by 2% next year due to slowing economic growth. A cooling economy would make $1 prices appealing to consumers. Its focus on convenience items has protected the chain from online and cross-border shopping trends. Dollarama reported higher sales per square foot and per store, compared to its US dollar store competitors.
Discounters in China
Wal-Mart and Tesco disappointed with the performance of their marketing campaigns in Singapore and the People’s Republic of China. Other foreign stores operating in Greater China seem to have similar issues. For example, Carrefour is closing sites in Singapore because of domestic competition. Foreign retailers hope that changing their promotions to better match local tastes might attract customers.
There is a more fundamental problem: many nationalistic shoppers do not intend to buy from foreign retailers. Businesses are also facing challenges China's slowing economy. Bloomberg Industries analyst Charles Allen explained, “The rate of same-store sales increases is not what they were expecting it to be.” He continued, “The rate of addition of capacity has probably exceeded the growth of the market.” As a result, Wal-Mart is very cautious about increasing the number of its planned grocery stores in China.
Discounters in Mexico: Growth and Bribery Allegations
There are some bright spots for Wal-Mart's international growth. Wal-Mart de Mexico is the largest retail store in Latin America. It has been able to overcome price pressure from competitors by slashing its own prices, gaining 11% in sales this quarter. Walmex (Wal-Mart in Mexico) secured 100.8 billion pesos ($7.9 billion) in revenues through extra promotional schemes.
Actinver analyst David Foulkes said, “The competition in the sector is more aggressive all the time.” Walmex responded to price promotions from competitors, including Controladora Comercial Mexicana and Organization Soriana, with its own round of aggressive price-cuts.
Amazingly, Walmex’s promotional strategy has not sacrificed profit. EBITDA actually increased 15% to 9.43 billion pesos.
Walmex is growing with 49 more stores opened in the third quarter and 162 in this year. Capacity will be expanded by 7.7% because of favorable business environment. Management is also planning to launch others sales schemes for food and cosmetic products to keep sales growth rolling next year. Walmex remains a leader in the Mexico’s retail market.
International growth may be stymied by the scandal of alleged bribery in Mexico and other foreign markets, driving crack-downs on Wal-Mart ventures. In addition, competitors leave little room for repositioning Wal-Mart’s value proposition.
Investors should shop around for low valuations. Oddly, many discount retailers are not offering discount price multiples:
Wal-Mart has mixed results internationally. As a result, we should expect a run of the mill valuation similar to the roughly 14 price-to-earnings average of the S&P 500 index. In fact, this is exactly what you see for Wal-Mart. This is hardly a bargain or a discount.
Unfortunately, dollar store format discounters are much more expensive, based on valuation. Look at Dollar General (NYSE: DG), Dollar Tree, Family Dollar Stores, and Dollarama. They all trade at higher price-to-earnings ratios and price-to-sales ratios than Wal-Mart. Other discounters like PriceSmart and Costco are similarly expensive based on valuation. They may be attractive companies with interesting stories, but they are not attractive stocks based on their pricing.
Instead, Target, Fred’s, and Big Lots (NYSE: BIG) provide lower valuations. Target is only a bit cheaper based on valuation than Wal-Mart, but it’s completely devoid of Wal-Mart’s bad press. Fred’s and Big Lots are cheaper based on valuation. Investors should look amongst these three stocks for value in the discount retailer industry.
I wish there was a dollar store name that stands out as a defensible investment. If there were any that were fairly priced I would have recommended them based on the fantastic growth in this store format, either in the U.S. or Canada. Unfortunately, market enthusiasm for this store format has made the dollar store stocks just too expensive based on valuation.
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