Dollar Stores: Cash Out?
Jane is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The dollar store phenomenon has brought investors wealth. But the high growth days of this industry, which IBIS World assesses at $56 billion, may be over, at least for now. The severity of the recession brought the concept high profile as low end consumers traded down from the big boxes and middle class ones lost their self consciousness about being seen in discount retail. Consequently, the niche became a favorite on The Street. However, as Motley Fool analyst Mercedes Cardona recommends, the timing may be right now to cash out from dollar stocks like Dollar General (NYSE: DG), Family Dollar (NYSE: FDO), and Dollar Tree (NASDAQ: DLTR).
Some have compared the upward trajectory in revenue, the stock price, and excitement surrounding the dollar stores to the dot.com rise and fall. That analogy seems off the money. The business of the dollar stores remains solid. Only it’s changing in ways that investors have to evaluate. One concern is its increasing complexity. Another is that competition from discounters such as Kohl’s (NYSE: KSS) has become more in line with dollar pricing as well as more aggressive. In addition, because the industry has low barriers to entry, the number of dollar stores is rapidly increasing. Also factors such as rising gas prices, a stronger recovery which could lead consumers to trade up, and popularity of ecommerce increase uncertainty.
Initially, the beauty of the dollar stores was the simplicity of the core business. There was no ambiguity about the concept. It was as unique as Staples’ had been when its mission in 1986 was to serve small business. Enough items in dollar stores were priced at a dollar to preserve the identity of amazing discounts. At that price point there was no need for coupons. There was no ecommerce. Primarily there was private label merchandise. There was no perishable food items. It was almost impossible for other kinds of discounters to compete. Small efforts have been tried as when Target set aside a few shelves in the front of its store in North Haven, Connecticut for dollar merchandise. However, soon enough that became diluted with items put alongside which were priced at $2.50.
Some experts, such as Bain & Company Consultants Chris Zook and James Allen who authored “Repeatability,” finger simplicity as the reason for the success of Apple, IKEA, McDonald’s, and Berkshire Hathaway. Great brands, they conclude, then leverage that simplicity, such as Apple’s i-products, to new developments. In its current issue, THE ECONOMIST points out how easy it has been for companies to drift away from a core business and no-frills management to complexity. The result can mean reduced focus, which adds to risk. An example of that might be Penney. Its model for fair and square pricing I find confusing. That increases the odds that I won't shop there.
The dollar store concept, as it is currently practiced by both chains and mom and pop independent retailers, tends to be short of simplicity. Family Dollar, which was started in 1959, has items over a dollar, all the way to $10. It has been adding more national brands. Perishable produce is sold. Its website provides coupons such as a 75-cents off one for a shampoo. That’s related, of course, to the store. However, the website seems to be developing into its own form of ecommerce. For example, a wireless phone can be purchased online.
Look at Dollar Tree’s website which provides items such as a $1 wine glass which is sold by the case of 36, with free shipping. Is the consumer retail model here slipping into wholesale and/or B2B? Will B2C come to view itself as a second class shopper?
Both in brick and mortar and online, Dollar General sells items way beyond a dollar and the household sundries category. On its website it sells an Emerson digital camera for $40 or $720 for a case of 18. Does this also indicate a drift into wholesale and/or B2B?
At the low end, the big boxes are more geared to compete with this diluted branding. Wal-Mart (NYSE: WMT) is learning from its mistake of reducing the kinds and number of low price, low margin merchandise to boost profit and margins. Ironically, its crisis in Wal-Mart de Mexico could trigger the kind of general review of operations, ranging from brick to clicks, to position it more strongly against the dollar stores. Right now Kohl’s seems in the catbird seat to poach customers. Its discounting packages of couponing, cash back on purchases, and daily deals, are awesome. Motley Fool blogger Matthew DiLallo chronicled how he and his wife left the store with about $100 in merchandise and only put out about three dollars in actual cash.
In addition, both dollar store chains and mom and pop dollar store outlets keep increasing in number, often in the same locations. For example, in the North Haven, Connecticut Universal Drive shopping center there are two dollar stores. Surrounding them are a Big Lots and Target. Overall, this competitive pressure can boost the need for heavy advertising and deeper discounting, slashing margins.
Since dollar stores are dependent on consumers willing to travel to shopping centers gas prices remain a wild card but maybe not as much as it does for other discounters. Some of the dollar chains made it their business to locate their stores not far from dense population areas. The rub is that their average shopper is low income and therefore putting gas in their tank to go to work can reduce what they spend on shopping. Here in the New Haven, Connecticut metro area regular gasoline is at around $4.11 a gallon.
A strong recovery could cause a flight from dollar stores to retail establishments offering more shopping ambiance. But that might not be in the cards. Earlier this year, Morgan Stanley predicted GDP growth at about 2% for the next two years. The 1Q GDP growth of 2.2% was in that ballpark. Some expected 2.5% growth.
What adds to the uncertainty is the explosive popularity of shopping online. UPS reported that its shipping volume is up 9.9%, with its next day air service up 5%. The bulk of that was generated by ecommerce. That brings up two issues. One, can the dollar stores compete with sophisticated ecommerce players like Kohl's? And two will there be less traffic in brick and mortar?
Like so many retail niches, the dollar store is in transition. It could be nimble like Apple and thrive. Or it could become stuck like Best Buy and become distressed. It might take time for investors to get a handle on how this concept survives both internal change and shifts in the marketplace. Therefore, for now, it might be prudent to cash in their chips.
janegenova 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. If you have questions about this post or the Fool’s blog network, click here for information.