From Discount Retailers to Dollar Stores - Where are the Smart Buys?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

According to my research, Target (NYSE: TGT) is a better investment than Wal-Mart (NYSE: WMT) and dollar store competitors in the discount retail space. Target is enjoying a better growth story and trades at lower multiples than Wal-Mart.

Wal-Mart Lowers Forecast

Wal-Mart has forecasted lower than expected profit expectations for the fourth quarter. Due to slow economic conditions, sales gains have fallen and share prices have also fallen in the last six months. The fourth quarter profit per share would be in the range of $1.53 to $1.58. This is slightly lower than expectations of analysts. Their expectation was $1.59 per share.

Prices have also been reduced by the company to attract shoppers in the United States. This has hurt profitability. Discount chains such as Dollar Tree (NASDAQ: DLTR) and Dollar General (NYSE: DG) have taken consumers reeling from slow economic conditions and 7.9% unemployment. The growing dollar stores are attracting consumers who are price conscious. Increased traffic to these stores is also attributed to its smaller format stores that allow for quicker trips to be made and by adding food items. Essentially, these stores are more convenient than big box stores. The leeway program has also been brought back in 2011 to increase sales. This year as well, it was brought back on Sept. 16 in order to attract holiday customers. This has led to increase in third quarter sales.

Third quarter sales for Wal-Mart stores that have been open for a minimum of a year have increased by 1.5%, less than the 2% growth expected by analysts. This is also below than the 2.2% gain in the second quarter. Net Income for the quarter ended Oct. 31 has risen to $3.64 billion ($1.08 per share), a growth rate of 9%. It is greater than 96 cents per share or a total of $3.34 billion last year, but less than the expected $1.07 per share. Net sales after accounting for cost of goods sold dropped to 24.46% in the third quarter. This is less than 24.59% a year earlier. The gain in the U.S. same store sales is the fifth straight increase in the largest market.

There are costs of the investigations that have been launched by the U.S. Department of Justice as well as the Securities and Exchange Commission. The investigations are pertaining to the Foreign Practices Corrupt Act at its unit in Mexico. Superstorm Sandy has also shown its effect on the company as the company announced that it has $36 million in pre-tax charges due to the storm.

On Target Results

Target has fared much better, posting solid third quarter results. Profits have increased by 15% due to boost in sales that could be attributable to its branded credit cards. Net income for the third quarter increased to 96 cents per share or a total of $637 million. This is an increase from 82 cents per share or a total of $555 million, a year earlier. This is in line with expectations as analysts have also predicted 96 cents. A one-time gain of 15 cents per share were included in the third quarter results. This gain is due to an agreement to sell its credit card portfolio to TD Bank last month. The Revenue from established stores has increased by 3.7% this year through October. The gain for the whole year is three percent. The Profit in the fourth quarter is expected to be in the range of $1.45 to $1.55 per share, in line with analyst expectations of $1.50 per share.  The fundamentals of the company are strong, leading to analysts recommending buying the shares.

In the past two years, Target has increased sales by adding more food to its stores as well as exclusive merchandise. Its best customers are also encouraged to spend by the 5% discounts on purchases made with the branded credit cards. These initiatives seem to be working. Comparable stores have increased this figure by 2.9% for the quarter. Total sales including revenue from the Credit Card Unit have risen by 3.2% to $16.93 billion. In spite of increasing sales, the new sales initiatives seem to have reduced profits. There might be a downside to these promotions as gross margin has declined slightly to 30.3%, less than 30.5% last year.

This is in relation to the fact that new store openings in the United States have slowed in order to prepare to open a store in Canada, the first store outside the United States.

Valuation Considerations

Target is cheaper than Wal-Mart and dollar store format competitors according to several price multiples:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>P/FCF</strong></p> </td> </tr> <tr> <td> <p>TGT</p> </td> <td> <p>Target</p> </td> <td> <p>13.86</p> </td> <td> <p>0.57</p> </td> <td> <p>2.5</p> </td> <td> <p>20.31</p> </td> </tr> <tr> <td> <p>WMT</p> </td> <td> <p>Wal-Mart</p> </td> <td> <p>14</p> </td> <td> <p>0.49</p> </td> <td> <p>3.1</p> </td> <td> <p>25.19</p> </td> </tr> <tr> <td> <p>DLTR</p> </td> <td> <p>Dollar Tree</p> </td> <td> <p>15.59</p> </td> <td> <p>1.24</p> </td> <td> <p>5.87</p> </td> <td> <p>22.55</p> </td> </tr> <tr> <td> <p>FDO</p> </td> <td> <p>Family Dollar Stores</p> </td> <td> <p>18.59</p> </td> <td> <p>0.82</p> </td> <td> <p>5.92</p> </td> <td> <p>NA</p> </td> </tr> <tr> <td> <p>DG</p> </td> <td> <p>Dollar General</p> </td> <td> <p>18.66</p> </td> <td> <p>1.04</p> </td> <td> <p>3.38</p> </td> <td> <p>38.26</p> </td> </tr> </tbody> </table>

Investors should consider Target as the cheapest price-to-earnings, price-to-book, and price-to-free cash flow discount retailer on this list. Its solid fundamentals make it more attractive relative to Wal-Mart given its lowered guidance.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus