The Smallest of the Dollar Store Companies Seems to Be the Strongest

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Over the years, and especially since the recession, dollar stores have become more popular as consumers were left with less money to spend. Even dollar stores are under pressure as of late, however, and are facing margin shrinkage and reduced sales of non-consumables as consumers shift more towards consumables purchases.

After Dollar General's (NYSE: DG) recent earning release, the company's stock saw a steep fall after the company reduced the earnings guidance that it had recently made for the current fiscal year. Apart from the cut in guidance, the company's current results also pointed out certain concerns as it missed the revenue forecast but met estimates on the bottom line.

The increase in payroll taxes and tax refund delays affected customers badly. The reduction of in-hand money reduced some customers and even employees to the point of stealing. This led to inventory shrinkage beyond expectation, increasing pressure on the company as it tries to limit this shrinkage. The company also blamed bad weather as the cause of the reduction in sales, and as weather improved the sales recovered, though they were still below expectations.

The company's margins are also getting worse as its product mix shifts from non-consumables, which carry high margins, to consumables. In consumables, however, many consumers are choosing items with lower margins; increasing tobacco sales is hurting the margins as well.

Does size matter?

Dollar General is the largest among dollar stores with 10,662 stores, and the company has plans to add 635 more stores in 2013. Dollar Tree (NASDAQ: DLTR) is second in terms of store count with 7,800 stores, and the company's management has plans to gradually triple that number to about 23,000 stores.

The problem with the herculean expansion plans of Dollar Tree is that it will increase the company's operating costs significantly and with an increase in sales of low-margin products, it could make the expansion unviable. Other stores are also expanding consistently as well, creating competition that will cause margins to shrink further and make survival of only the most resilient stores possible. 

One and the same troubles

Family Dollar Stores (NYSE: FDO) is also facing the same troubles as Dollar General, including the increase in payroll tax, delay in getting tax refunds, bad weather, higher gas prices, and other economic problems. Family Dollar's margins have also shrunk, and as it plans to expand its tobacco offering its margins might be affected further. Family Dollar has been the worst performer among its peers, reporting a decline of 3% in its stock prices while the others have gained.

Family Dollar's management has failed to meet its own expectations from the previous quarter. Management has also cut its earnings forecast for the second time this year. I strongly believe that management failing to meet its own expectations over and over again while trimming earnings projections will only hamper investors’ confidence in the company and nothing else.

A different story altogether

The single-price-point retailer Dollar Tree has been the best performer among all of the dollar stores, surging about 23% this year. Though it is the smallest player, its smart and methodical strategy for expansion and a focus on productivity has kept it ahead of competition.

Dollar Tree has consistently focused in its discretionary business practices and worked on its $1 price point to attract customers. The company has been able to draw customers' interest with candies, stationary, and healthcare products instead of low-margin consumables. Further, it is not selling tobacco like other dollar stores, something that helps it to keep its margin in good shape.

Dollar Tree's revenue has risen 8% while the industry average has only improved by 6%, and its net sales have improved by around 15%. While its competitors are cutting their guidance and failing to meet their own expectations, Dollar Tree has beaten its estimates on earnings-per-share and raised its full-year guidance to a range of $2.61 to $2.77.

As Dollar Tree's shares are presently trading in the range of late $40's, well below its 52-week high of $57 a share, investors can expect the prices to surge from this range.

Final take

Both Dollar General and Family Dollar are finding it hard to keep their margins and profitability intact, which will likely result in them not being as lucrative as before. As long as the economy and payroll taxes remain volatile, these companies might too find it difficult to please investors. Dollar Tree seems to be going ahead strong with all its strategies working well in its favor, however, making it a smart pick.

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tarun bachhawat 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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