Can This be a Dollar Store, Literally?

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A typical discount store is one that sells products at prices lower than those asked by traditional retail outlets, with most of them offering a wide assortment of goods while others specialize in such merchandise as jewellery, electronic equipment, or electrical appliances. Post-recession, discount retailers gained great strength as many customers traded down from regular retail channels. Dollar stores gained a particular popularity owing to their product prices, which are far below the supermarket average, and their strategic store locations, which make them easily approachable.

Among dollar stores, Dollar General (NYSE: DG) is one of the major players that recently reported disappointing first quarter results, leading to a decline in its share price. However, it does have some expansions planned for its stores, which can lead to increased profit margins in the near future.

Plans on the shelf

The company has come up with expansion plans of 365 new stores and relocation of 550 stores in the U.S. by the end of 2013, which includes 20 Dollar General mini-supermarkets, 40 Dollar General plus-stores, and the remaining will be in the core Dollar General format. This will help them in widening their retail market by 7%, thereby increasing profits.

To please their customers, all its new stores in Dollar General Market and Dollar General Plus format stores will have more coolers/freezers this year. This will keep customers happy, as it will offer them fresh produce and meat.

Tobacco is good for its health

Not only has the company planned well in order to satisfy their customers, but it has also understood customer demands and has used them to increase their revenue. Looking at the increasing demand for tobacco in competitors’ stores, Dollar General also thought of testing tobacco sales in 50 of its stores in Florida.

The plan was a success. It was noted that in stores which did not sell tobacco the average purchase of a customer was $11, whereas in stores where tobacco was available the average purchase was $14. Moreover, the stores reported sales of approximately 33% more tobacco than planned by the company. Looking at the positive results, the company plans to make tobacco available in more than 10,500 locations across the U.S. By the end of 2013, the company’s tobacco business is expected to generate additional revenue of $36 million.

Stores in the neighborhood

Dollar Tree (NASDAQ: DLTR) is a strong competitor with a market cap of $11 billion, and has been one of the best-performing companies in the sector this year. The company will continue to maintain its position with continuous square footage growth and the expansion of its online channel Dollar Tree Direct. In FY13, it is expected to open 340 new stores with the relocation of 75 stores in the US and Canada. It has already opened 94 new stores and relocated and expanded 16 stores in the first quarter of this year, thus increasing its square footage. It will also lift sales with its chain-wide MasterCard roll-out in FY 2013.

Family Dollar Stores (NYSE: FDO) has shown a decline in performance and has reported 146 bps lower gross margins than the consensus estimate from last quarter's results. It has been facing a lot of economic problems and has shown a decline of 3% in its stock price. However, with its new “Fee Development Program” the company is expected to do better in the second half of this year. This program is intended to provide it with a more cost-effective means to finance the construction of new store locations. Stores will be developed and sold or leased back on margins to be run by others.

Numbers on the price tag

To increase free cash flow, Dollar General has allocated $300 million as capital expenditure and $155 million as working capital investment. This will result in a cash flow of $666 million by the end of this year, compared to $536 million last year. The company also aims at increasing their sales growth from 8.5% in the first quarter of 2013 to 12.4% in the fourth quarter of 2013.

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DG PE Ratio TTM data by YCharts

Compared to its peers, Dollar General has the highest operating margin of 12.41% and the lowest P/E TTM of 18.62. Dollar Tree reported an operating margin of 11.61% and a P/E TTM of 19.73, which is the highest among the three. Family Dollar Store has the lowest P/S ratio of 0.65, but also the lowest operating margin of 7.5% and a relatively higher P/E TTM of 18.72.

Thank you for shopping!

Looking at the numbers, Family Dollar Stores is presently facing economic problems and suffering from low gross margins. So, I would suggest a sell at current prices.

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FDO data by YCharts

As for Dollar General and Dollar Tree, both have promising plans to increase revenue and their markets this year. Dollar General is trying to provide fresh produce to the customers and also increasing its revenue with tobacco rollout across all states. Similarly, Dollar Tree has implemented square footage growth to increase its selling space. Both of them look equally promising, and therefore I rate both these stocks as a buy.

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Dhara Thakkar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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!

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