A Solid Stock + a Solid Industry = a Potential Buy
Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
What’s the go-to stock when the economy is in a volatile state? The answer is simple – a company that enables consumers to save their dollars, or more specifically, a discount retailer. The sovereign debt crisis in Europe and a slowdown in Chinese economic growth indicate that the road to recovery will be a difficult one, and till we again reach the boom phase, consumers will try to stretch their dollars as much as possible.
But as more and more consumers try to keep their wallets on a tight leash, a select group of companies would stand to gain as a result of austerity on the buyers’ part. This select group of companies is none other than the dollar stores triumvirate of Dollar General (NYSE: DG), Dollar Tree (NASDAQ: DLTR) and Family Dollar Stores (NYSE: FDO).
Discount retail – making investors rich, come what may
All three of them have witnessed a steady growth in their top line over the past five years as shown by the following chart:
Their revenue increased during the U.S. recession triggered by the sub-prime crisis, and this is not at all surprising. But during the following years, recovery was choppy and the sovereign debt crisis began rearing its ugly head in late 2009. This led to a lack of visibility as far as economic recovery was concerned and hence, these dollar stores kept cashing in on the cash-strapped consumer.
But those who had invested in these companies were not complaining. As these dollar stores were helping the cost-conscious customer buy things for cheap, they were also adding glitz to their investors’ portfolio even though the European conundrum was gathering momentum:
Losing out to the General?
But we know that all stocks aren’t created equal and we need to single out the best one in the pack. Dollar Tree’s guidance hasn’t been inspiring over the last couple of quarters and its stock has been on the decline over the last three months after an impressive beginning to the year.
While it might seem that Fool analyst Sean Williams’ opinion that “A mixture of low wage growth and rising food prices has pinched consumers to the point that I couldn't figure out how dollar stores would squeeze any more out of their customer base” could have been the reason behind Dollar Tree’s muted guidance, Dollar General quashed these fears with its own quarterly report.
Dollar General – the boss
Dollar General easily beat analyst expectations in the second quarter and increased its profit forecast and same-store sales growth forecast for the year. With due respect to Sean’s analysis, I believe that low wage growth and escalating food prices are the reasons why consumers flock to dollar stores, and Dollar Tree’s downbeat guidance could be a result of a loss in market share to Dollar General.
With an army of more than 10,000 stores and counting, Dollar General is well positioned to gain from a flailing economy. With same-store sales growth of 5.1%, the discounter outpaced its rivals, and its guidance suggests that it is ready to capture some more market share.
Moreover, Dollar General’s foray into California should provide further impetus to its operations. The company doesn’t have much exposure in the state and its recently-opened 27 stores which have been doing pretty well. Furthermore, Dollar General aims to open another 23 stores in California by the end of the year and open up more avenues for growth in the process. On an absolute basis, the company now intends to open 625 new stores this fiscal while remodeling or relocating 575 stores.
With its plans of opening more stores and improvement in offerings, Dollar General can do even better. Management states that the company is witnessing improvement in market share and the trend looks set to continue in the future.
Family Dollar is up next
As far as Family Dollar is concerned, we shall wait and see what tune it sings when it comes up with its own set of numbers later this month. It had missed estimates last time and its guidance failed to make the Street’s grade. However, with more than 7,000 stores and a growing portfolio of products, Family Dollar seems to be the second best behind Dollar General.
In addition, Family Dollar’s tie up with Coinstar (NASDAQ: CSTR) for Redbox kiosks might be another driver for its top line. Coinstar would offer DVDs, games and Blu-ray discs at these kiosks for rent with rates beginning at $1.20.
According to Nick Mitchell of Northcoast Research, Redbox can contribute $50 million in revenue annually to Family Dollar if kiosks are placed across 80% of its stores, adding another 15 cents to the bottom line in the process.
Dollar stores have performed very well in times of economic uncertainties and should continue to do well. However, it seems that Dollar General is the best bet of the lot with its huge number of stores and wide range of merchandise. It sports the lowest PEG (price/earnings to growth) ratio of 1.02 among its peers, which further signifies that Dollar General is more undervalued than the others. It has already appreciated 25% so far this year, and should get better as the year progresses.
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