Take a Look at Dollar Stores; Earnings Strong for Retail Space

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There is a train of thought out there that dollar stores don’t make for good investments and that any success they are enjoying now will soon come to an end.

The logic is that these stores performed well during the recession because consumers had fewer discretionary dollars to spend. They chose discount stores instead of pricier outlets to buy their goods. So now that the economy is picking up, some observers say these stores won’t be as popular as consumers will fall back to their old spending habits and shop at the pricier stores. This will affect the market share and profits of the dollar stores, according to some observers.

However, I do not think this will be the case. If for no other reason, the recession taught many consumers to be more budget conscious. I don’t think they will throw caution to the wind and abandon dollar stores. Furthermore, dollar stores aren’t like what they used to be, in that they offer better merchandise. Some even sell food. This should help them to remain competitive with the Targets and Wal-Marts of the retail world.

Let’s start with Family Dollar (NYSE: FDO). Of all the dollar stores, it seems that Family Dollar is the truest example of “beauty is in the eye of the beholder.” Its worthiness as a sound investment in the dollar store space is debatable. For example, just last week two firms expressed completely different views about the stock. Deutsche Bank upgraded Family Dollar to ‘buy’ from ‘hold.’ Citigroup on the other hand downgraded the retailers to ‘neutral’ from ‘buy.’

Concerns include margin declines, expenses and price wars among the dollar stores. The store even admitted that it was facing margin pressures when it released its first quarter earnings in January. Sales of lower-margin consumables have been strong, but that raises margin concerns. These concerns can be partly mitigated by the company lowering its freight expenses and implementing higher markups on its merchandise.

When it reported its first quarter earnings in January, Family Dollar unveiled a 12.7% increase in net sales. They totaled $2.42 billion.

Family Dollar has been on a tear when it comes to opening new stores. Part of the expansion has come under fire because it seems the chain is saturating low-income neighborhoods with its stores. While the practice has helped to boost profits for the chain, it has drawn sharp criticism. We’ll see how the company’s margins and sales held up during the second quarter on April 10 when it reports earnings.

As Family Dollar prepares to release its next earnings report, it’s dealing with a lawsuit shareholders brought over the guidance it provided last year for the first quarter of 2013. Specifically, they say that “the company failed to disclose that it was experiencing much softer than anticipated demand … resulting in much lower first quarter 2013 profits than anticipated.” The shareholders also charge that the disclosure failure has led to a build-up of merchandise that can’t be sold.

Dollar General (NYSE: DG) has not had such problems over the guidance it issues. In fact, investors delighted in the guidance it issued for the next quarter, as well as the strong earnings it reported for the last quarter. It reported its fourth quarter and full year 2012 results last week. Being able to grow its market share is one of the reasons its earnings increased.

Its net sales increased during the fourth quarter, but just by .5%. They totaled $4.21 billion. As far as guidance is concerned for 2013, Dollar General forecasts total sales increasing by 10% to 12%.

Then there is Five Below (NASDAQ: FIVE). As a dollar value retailer for teens, it is one of the most recent players in the dollar store space to release earnings that showed strong growth.

Net sales increased by 41% to $418.8 million. Furthermore, net income increased to $20 million compared to $16.1 million in fiscal 2011. It’s also noteworthy that the company reported significant sales growth during the holiday shopping season. Sales growth was 41%.

Despite balks from some Wall Street players, I found Five Below's guidance sound and impressive. For the first quarter of fiscal 2013, net sales are expected to be in the range of $92 million to $94 million. For fiscal 2013, net sales are expected to be between $516 million and $521 million. These increases are based on the company opening several new stores.

I think these dollar stores will continue to perform strongly as part of the retail sector, and their valuations will be buoyed by consumers who will continue to seek out the best value from their purchases.

Tedra DeSue 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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