Discounted Discounters

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A recent survey shows that dollar stores expanded their market share recently, even though some investors lost confidence in these discounters' prospects. The CSP Daily News reported that a Perception Research Services International survey showed that dollar stores attracted more grocery shoppers in 2012 as mass merchandisers' market share weakened slightly. More traffic could help dollar stores beat the earnings estimates like they did last holiday season, so the dollar stores' dips may mean buying opportunities.

October didn't start off well for the dollar stores. On Oct. 11, Dollar Tree (NASDAQ: DLTR) warned investors that fuel costs crimped dollar shore shoppers' budgets, sending Dollar Tree down 7% and Dollar General (NYSE: DG) and Family Dollar (NYSE: FDO) down around 2%, reported Reuters. On Oct. 17, Dollar General led the dollar stores down with a 6% loss, and explained that a group of investors might have heard bad news from Dollar General during a visit to its Tennessee offices. With their main customers cutting back spending, dollar stores cut their own forecasts as well.

Even if their regular shoppers have smaller budgets, dollar stores' bargains may still attract new customers. Investors knew dollar stores typically served customers who couldn't spend much, but wealthier shoppers who wanted to conserve their cash might also visit dollar stores, especially during a bad economy. The survey shows that some shoppers who bought higher priced products before have switched to the dollar stores, which could mean visits from shoppers that the dollar stores didn't expect to show up.

The dollar stores' cautious estimates resulted in earnings beats in the last quarter of 2011. Dollar stores' revenue and earnings show seasonal effects, so Q4 results provide the most insight into these retailers' health. Istockanalyst reported that Dollar Tree earned $1.60 per share in 4Q 2011, beating estimates of $1.59 per share. In 4Q 2011, Family Dollar earned $1.15 per share, which surpassed analysts' expectations of $1.13 per share, explained Accessories Magazine. Dollar General's 85 cents per share figure for 4Q 2011 also beat expectations of 82 cents, reported Accessories Magazine. A weak October means that earnings beats this holiday season aren't priced in for the dollar stores either.

Although the dollar stores' growth premiums aren't completely gone, these stores offer much more attractive valuations now. Family Dollar has a 1.05 PEG, although an earnings beat could still make this price look attractive. Dollar Tree has a 0.88 PEG right now, which might mean that investors have undervalued its growth already. Dollar General, with an 0.91 PEG, may also offer growth at a discount. All three stores have trailing P/E ratios of 18 right now, so investors do expect some growth.

More shopper visits to dollar stores could also mean smaller discounter Fred's (NASDAQ: FRED) has an opportunity to attract some new customers. Fred's also beat the estimates in 4Q 2011, earning 25 cents per share while analysts expected 24 cents, reported the Associated Press. Although Fred's 1.24 PEG looks pricier than the dollar stores, this discounter's 14 trailing P/E suggests lower growth expectations, so an earnings beat could come as more of a surprise.

Dollar Tree looks like the most attractive dollar store right now. Although sell-offs knocked all three dollar store chains down to similar P/E ratios, Dollar Tree's PEG suggests that this store deserves a slight premium. Dollar Tree's 7.57% profit margin also shows that this store could gain more income than competing discounters if dollar stores gain market share. Investors should consider Dollar Tree's warning, but this store beat the expectations last year and more dollar store shoppers could help it beat expectations this year as well.

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