Discount Retailers Boosted by Change

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

During the recent economic and financial crisis, discount retailers flourished in the US. The shrinking middle class and declining median household incomes have led to a drastic change in the spending habits of US residences over the years. Aided by greater availability of information and poor economic conditions, more and more shoppers are actively searching for bargains and value. And per a Kantar Retail report, this change in consumer shopping habits is expected to persist for the long term.

The focus of the discount retail industry has been shifting away from big box stores towards smaller stores. I have picked three of the largest and most actively traded mid- to low-tier retailers, with an average store size below 10,000 square feet. Dollar General (NYSE: DG), Dollar Tree (NASDAQ: DLTR), and Family Dollar Stores (NYSE: FDO) each have achieved high revenue growth over the last five years, growing at or above par to the industry averages.

Dollar General, the largest discount retailer, operated 10,662 stores as per the most recent quarterly report. The company has achieved a CAGR in revenues of around 11% over the last five years and recorded revenue of $16 billion in FY 2013. The growth in revenues is driven by a 7% per annum increase in selling square footage and a 4.7% improvement in the net sales per square footage. The increase in per square footage sales can be attributed to increased traffic in the company’s stores. The higher per square foot sales also helped the company in improving its net margin over the years, from 1.03% in 2009 to 5.95% in 2013.

Family Dollar operates more than 7,800 stores, and despite this strong outreach the company could only achieve a CAGR in revenues of around 6.4% over the last five years. The company recorded revenue of $9.331 billion in FY 2012, making it the second largest dollar retail store in the US. The slow growth in revenues is largely attributable to a slow expansion of its square footage, at only 3.52% per annum. However it achieved a respectable 4.5% per annum increase in its per square foot sales. Slow expansion of the company in the last few years stems from revamping its existing outlets in order to enhance its appeal to customers. However, in the current fiscal year, the company has opened 359 new outlets, expanding its square footage by an annualized rate of more than 7%. Due to its slow expansion, the company showed little improvement in its net margin, growing to 4.53% in FY 2012 from 3.34% in FY 2008.

Dollar Tree Stores achieved the highest CAGR in revenues of around 11.75% over the last five years, reaching almost $7.4 billion in revenues in FY 2013. The company operated 4,612 stores as of May 2013, a relatively low number compared to its peers. However, the stores operated by Dollar Tree have a higher average selling square footage per store of more than 8,500 square feet as compared to the mid to low 7,000 square foot store sizes of its peers. The high growth in revenues as compared to its peers is attributable to a 7.52% per annum growth in selling square footage and a 4.7% per annum growth in sales per square foot. The high growth achieved by the company has enabled it to improve its net margin from 4.94% in 2009 to 8.38% in 2013.

Conclusion

Slow growth and prevailing economic uncertainty are going to be highly beneficial for US discount retailers. Even deflated consumer confidence and the recent unexpected decline in the housing market seems to suggest that the recovery in the US economy is going to be slower than expected. This means that the economic environment in the US is not going to change substantially any time soon. This will lead to an increase in traffic at discount retailers and give them ample opportunity in the coming years to continue growth similar to that achieved in the last five years. Also, as mentioned above, the change in consumer spending habits has boosted the traffic experienced by these retailers, and will continue to do so. It is because of these reasons that PWC and Kantar Retail forecast discount retailers as the fastest growing store-based retail category, with more than 7% growth through to 2020.

I rank Dollar General and Dollar Tree as strong buys. Dollar General has a growth-oriented focus and substantial cash flows, which will enable the company to continue growth in the future. Dollar Tree has grown substantially over the years and is expected to continue growth through further expansion of operations in the US as well as Canada, and this growth will enable the company to sustain its high margins.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


Hussain Asghar 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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