Fast Growth in an Obvious Sector
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The growth in lower priced and dollar store chains shouldn't be a great surprise. The economic turmoil of the last few years has caused shoppers to watch their spending more carefully. Dollar stores are easier to get in and out of than larger stores, and seem to offer good value.
One chain that has been cashing in on this dollar denominated sales model is Dollar General (NYSE: DG). The company's results were impressive, and if analysts are to be believed, this is just the beginning.
When it comes to dollar-denominated retailers, there are basically three major players. Dollar General and Family Dollar (NYSE: FDO) both sell items based on a whole dollar pricing system. In other words, both are not “dollar stores” where everything is packaged at the $1 price point, but instead items are priced at a whole dollar price. You won't find deals like laundry detergent for $4.99, instead it would be $5. Generally speaking, these retailers don't carry as many choices as traditional retailers, but what they lack in breadth they make up for in price. By offering off-brand or private-label brands at a low price, stores like Dollar General can offer deals for consumers looking to buy just the necessities.
Dollar Tree (NASDAQ: DLTR) is the more traditional dollar store retailer, offering primarily a single price point of $1 for each package in the store. This type of retailer is expected to see significant growth going forward as well. Dollar Tree benefits from what I refer to as perceived value. The customer sees items that they don't expect to be sold for $1, and assumes that they are getting a better value than they could elsewhere.
However, this is where product mix is important to the profits. I've shopped at both Dollar Tree and Dollar General before. While their prices are better in certain cases, they also tend to sell off-sized items. I might be able to buy a box of cookies from Target (NYSE: TGT) with 30 cookies for $2, whereas at Dollar Tree 12 cookies might be $1. This might not seem like a big difference, but at Target that is $0.07 per cookie versus $0.08 per cookie at Dollar Tree. Most consumers just see a package for $1 and assume they are getting a better deal.
Speaking of Target, traditional retailers like this one have also caught on to this dollar-denominated pricing idea. Target offers a “dollar spot” near the entrance to their stores where everything is priced at a dollar. This lower price per item encourages impulse buys and increases the customer's average ticket. Long story short, customers are very comfortable with dollar priced retailers and this perceived value is helping the entire industry to grow. Dollar General is benefiting directly from this phenomenon and it's evident by their recent earnings report.
Dollar General recently reported revenues up 10.4% and significant EPS growth of 33%. Consumable sales make up nearly 74% of the company's total and increased over 11%. Dollar General also said that same-store sales increased 5.1% on the back of both increased traffic and an increased transaction size. The company also saw impressive growth in sales in its other categories. Even the worst division apparel showed an increase of 4.2%. Dollar General's strong sales also helped the company's financials as well.
Dollar General generated 30.74% more operating cash flow in the first six months of the year versus last year. This increase allowed the company to produce almost $270 million in free cash flow. In a maneuver that I expect the company will continue to utilize over the next few years, the company retired some of its higher interest rate debt to issue newer low interest rate debt. Dollar General redeemed $500 million in notes that had double-digit interest rates, and issued $500 million in new debt at about 4% interest. This transaction alone saved the company around $25 million in interest during the quarter. The company's strong cash flow also allowed them to retire almost 3% of the diluted shares on a year-over-year basis. The company's confidence in its future also prompted management to authorize an additional $500 million in share repurchases.
Dollar General expects sales to increase between 10% and 11% on a comparable 52 week basis. With between 4% and 5% same-store sales growth, and better overall sales, the company now expects EPS for the year to come in at $2.73 or more. Dollar General also is speeding up its square footage growth by opening about 625 stores including 40 Dollar General Market stores. This represents an increase in square footage of about 7% versus a 6.7% increase last year. Investors looking to benefit from this dollar-denominated sales practice have several options.
In the dollar-denominated retail segment, the two fastest growing chains are supposed to be Dollar General and Dollar Tree. Both companies offer growth rates north of 17%, with forward P/E ratios of about 18. For exposure to the sector with some income, investors could consider Family Dollar. The company pays a yield of about 1.33%, but is expected to show slightly slower growth at about 14%. If investors want a more diversified play with a smaller amount of exposure, Target could be a good choice as well. Target's dollar spot concept is prominently placed and allows the company to capture some of the impulse buying that occurs in dollar stores, with the expanded selection of a traditional retailer. Target also offers the best yield of the bunch at about 2.26%.
As you can see from top to bottom, dollar-denominated retailers are all expected to do well. Use this information as a starting point for your own research and see if you should add one of these companies to your portfolio.
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