What Dollar Store Apocalypse?

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Dollar General’s (NYSE: DG) earnings release the other day sent the stock price of the leading dollar store chains into a downward spiral with Dollar General, Family Dollar (NYSE: FDO) and Dollar Tree (NASDAQ: DLTR) declining 3%, 7%, and 2% respectively. Words of caution from executives about 2013 served as the primary catalyst for the recent dollar store bear market. The recent stock price declines provide an opportunity for investors with a long term outlook.

With that said, let’s see how the companies fared in their most recent quarters:

<table> <tbody> <tr> <td> <p><strong>Numbers   in thousands except percentages</strong></p> </td> <td> <p><strong>Dollar   General (MRQ)*</strong>(+/-) from same time   in 2011</p> </td> <td> <p><strong>Family   Dollar (MRQ)*</strong></p> <p>(+/-) from same time in 2011</p> </td> <td> <p><strong>Dollar   Tree (MRQ)*</strong></p> <p>(+/-) from same time in 2011</p> </td> </tr> <tr> <td> <p><strong>Revenue   </strong></p> </td> <td> <p>$3,964,647 (+10.30%)</p> </td> <td> <p>$2,364,165 (+10.80%)</p> </td> <td> <p>$1,720,500 (+7.80%)</p> </td> </tr> <tr> <td> <p><strong>Gross   margins</strong></p> </td> <td> <p>30.93% 3<sup>rd</sup> Qtr 2012</p> <p> </p> <p>31.04% 3<sup>rd</sup> Qtr 2011</p> </td> <td> <p>33.83% 4<sup>th</sup> Qtr 2012</p> <p> </p> <p>34.00% 4<sup>th</sup> Qtr 2011</p> </td> <td> <p>34.90% 3<sup>rd</sup> Qtr 2012</p> <p> </p> <p>35.10% 3<sup>rd</sup> Qtr 2012</p> </td> </tr> <tr> <td> <p><strong>Operating   income</strong></p> </td> <td> <p>$361,389 (+16.00%)</p> </td> <td> <p>$132,657 (+0.67%)</p> </td> <td> <p>$184,200 (+11.70%)</p> </td> </tr> <tr> <td> <p><strong>Net   income</strong></p> </td> <td> <p>$207,685 (+22.00%)</p> </td> <td> <p>$80,931 (+1.40%)</p> </td> <td> <p>$155, 400 (+48.70%)</p> </td> </tr> <tr> <td> <p><strong>Free   cash flow (YTD)</strong></p> </td> <td> <p>$238,404 (-1.50%)</p> </td> <td> <p>($179,118) (-505%)</p> </td> <td> <p>$76,700 (-37.10%)</p> </td> </tr> <tr> <td> <p><strong>Comparable   store sales</strong></p> </td> <td> <p>+4.00% 3<sup>rd</sup> Qtr 2012</p> <p> </p> <p>+6.30% 3<sup>rd</sup> Qtr 2011</p> </td> <td> <p>+5.40% 4<sup>th</sup> Qtr 2012</p> <p> </p> <p>+5.60% 4<sup>th</sup> Qtr 2011</p> </td> <td> <p>+1.60% 3<sup>rd</sup> Qtr 2012</p> <p> </p> <p>+4.80% 3<sup>rd</sup> Qtr 2011</p> </td> </tr> </tbody> </table>

Source: Company Investor’s Relations and SEC Filings
*Most Recent Quarter.

Wall Street had plenty of reasons for its fears. Product shifts toward consumables, increasing fuel costs and theft contributed to the shrinkage in gross margins. Fears surrounding the fiscal cliff, consumers cutting back on trips due to fuel costs, and overall uncertainty concerning 2013 put the skids on comparable store sales.

This doesn’t spell doom and gloom.

Looking ahead

The massive investment in infrastructure from the dollar store chains tells me they intend to stick around for a while.

Distribution – All three of the leading dollar stores plan to invest heavily in their distribution networks according to their latest earnings calls. Dollar General plans to have another distribution center operational by 2014 in Pennsylvania. Dollar Tree plans to open a distribution center in Connecticut to support expansion in the northeast. Family Dollar opened its tenth distribution center in Indiana and plans to open its eleventh in Utah next year.

The investment in distribution centers stems from expansion plans for all three retail chains. Dollar General, Dollar Tree, and Family Dollar opened 625, 395, and 475 stores respectively in fiscal year 2012.

Wal-Mart Strategy – Dollar General’s response to the invasion of the micro Wal-Mart (NYSE: WMT) includes building larger stores. The Dollar General Markets and Dollar General Plus include groceries and other merchandise in larger format stores. In the third quarter of 2012 Dollar General opened 34 Markets and 24 Plus format stores.

Dollar Tree stands uniquely situated relative to the other dollar store chains. Most Dollar Trees situated near a Wal-Mart benefit from traffic brought in by the anchor store.

Private Labels – Private labels provide a win-win for consumers and dollar store shareholders by providing good value for the consumer and a high margin product for the company. As consumers experience increasing economic pressure, the desirability of these brands will increase.

The dollar store chains realize the significance of the value conscious consumer. Dollar General plans to add 150 private label brands in the near future. Family Dollar introduced 400 private label SKUs and plans on adding 500 more in fiscal year 2013 according to its latest conference call.

Impulse Buying Beverages also serve in the overall strategy of increasing same store sales through increasing impulse buying by locating chilled beverages near the registers. Installation of refrigeration units is one reason behind new dollar stores being built and old ones undergoing remodeling.

Family Dollar introduced tobacco products into its stores to boost impulse buying at the registers. Dollar General plans to follow suit, indicating that tobacco “indexes well” with its consumers.

The Takeaway

Investments and strategies to expand and increase same store sales tell me the dollar store chains don’t foresee a 2012 apocalypse anytime soon. In fact, they plan to continue for some time. Their efforts also demonstrate their preparedness in dealing with Wal-Mart’s recent entry onto their turf.

Recent stock price declines for all three bargain retailers provide an opportunity for investors with a long term outlook. However, Dollar Tree represents the best investment for three reasons: 1) It benefits from Wal-Mart’s proximity rather than competing with it, 2) it possesses the lowest P/E ratio (16), and 3) it had the highest growth in net income.

I gave Dollar Tree a thumbs-up on Motley Fool Caps.

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