Do These Dollar Stores Deliver Real Value?

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

Dollar stores have become all the rage among some value investors because of the success of Family Dollar (NYSE: FDO). It is easy to see why companies like Family Dollar, Dollar General (NYSE: DG), and Dollar Tree (NASDAQ: DLTR) have high profit margins and rising share prices--but do they deliver real value?

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Dollar General delivered a quarterly gross profit margin of 31.99% on July 31. That was higher than Wal-Mart (NYSE: WMT), which had a quarterly gross profit margin of 25.06%, but was lower than Dollar Tree or Family Dollar. Dollar Tree had a quarterly gross profit margin of 35.18%, while Family Dollar delivered a quarterly gross profit margin of 33.83%. So dollar stores like Dollar General do beat Wal-Mart in one metric: they deliver higher profit margins. But does this make for real value?

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Well, Dollar General currently has an enterprise value of $18.28 billion on a chain that reportedly operates over 10,000 stores. This enterprise value has fallen in the last year, even though Dollar General, like Family Dollar, is expanding like crazy. One has to wonder if all that mindless expansion is beginning to undermine the company’s value. Despite its size, Dollar General generated just $1.026 billion in cash from operations.

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Interestingly enough, Dollar General makes more cash from its operations than either Dollar Tree or Family Dollar. Family Dollar only made $369.37 million in cash from operations, a figure that has fallen drastically in recent years. Dollar Tree made around $707.10 million in cash from operations, a figure that is increasing.

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The fall in cash from operations might explain why Family Dollar has decided to offer items like tobacco, beer, and wine; it needs to generate more cash, and fast. Neither Dollar General nor Dollar Tree sells those items.

Interestingly enough, the no-cigarette strategy seems to be working at Dollar General; the company’s revenues have been going up steadily for the past few years, just like its cash. So Dollar General is in better shape than Family Dollar, even though its share prices are lower.

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Family Dollar’s revenues have also been going up at a similar rate, but at $9.331 billion, they’re still substantially lower than Dollar General’s. Both chains have done a really great job of increasing revenue, even in the midst of a huge expansion. Business has been good, but there is a cloud on the horizon in the form of Wal-Mart.

Wal-Mart Has New Threat to Dollar Stores

Wal-Mart is aggressively competing with the dollar stores through its “Neighborhood Markets”, a fancy name for a grocery store. The goliath from Bentonville is now the number two grocer in the Sacramento market, where it has opened four stores in two months.

The Neighborhood Markets are usually presented as threat to grocers like Kroger and Safeway, but they’re also a major challenge to dollar stores. These stores are designed to appeal to the same low income shoppers that are the main markets for the dollar stores. They are often located in the same neighborhoods, and they offer a larger selection of products than the dollar stores at comparable prices.

The Neighborhood Markets have one of the same appeals as the dollar stores. They offer big box prices without requiring shoppers to drive to the big box. Neighborhood Markets can also attract a middle class clientèle that may not want to set foot in a dollar store.

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Even with the potential threat of Wal-Mart’s Neighborhood Markets, Dollar General seems to be a good buy. It generates more cash, offers steadily rising revenues, and has a lower share price. Dollar General seems to be undervalued right now; it is the larger company with higher revenues, yet its shares are priced nearly $20 a share lower than Family Dollar’s.

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If you want to take the dollar-store plunge, Dollar General is more of a value than Family Dollar. It is cheaper, and many of its numbers are better than Family Dollar’s, although both chains are expanding dramatically in an unstable market and facing some serious completion from Wal-Mart. That's why the value in this sector might not last very long.

StockCroc1 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Family Dollar Stores. 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.

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