Wednesday, January 5, 2011

Family Dollar and BJ's Wholesale Figures Don't Matter

Family Dollar and BJ's Wholesale Club  gave results today and disappointed the market with their sales guidance for 2011. On initial reading this does not seem to be reflective of a weak retail sales season.  However, it does seem to be representative of the problems of the lower income demographic that Family Dollar is focused on. Is this ultimately a problem for US retail spending?

I don’t think so!


US Income Inequality

The discounters (Family Dollar, Dollar General, BJ'sWholesale etc) always will have their profitability affected by marginal movements in income and expenditure of lower income demographics. However, the US has such an inequality of income in the States that a bifurcation of prospects tends to take place under certain conditions. I decided to look at some income distributions by quintile. These figures show the share of national income taken by different income groups.

 
Low 20%
Next 20%
Mid 20%
Next 20%
Top 20%
% of  Income
3.4
8.9
15.3
23.9
48.5
% of Spending
8.2
12.6
17
23.5
38.6
source: Earnings View, Census of the Bureau



So the bottom 60% of the population does not spend as much as the top 20% Moreover, there are other factors that influence these numbers. For example, lower income groups spend much more of their income on gasoline and consumer staples such as foods. These prices have been rising recently and I would expect this to eat into their discretionary income.

 

Commodity Food Price Index - Monthly Price - Commodity Prices


and

Crude Oil (petroleum) - Monthly Price - Commodity Prices


The discounters had been doing well with customers 'trading down' into using their lower cost options but this trend seems to have slowed. The real problem with Family Dollar and BJ's latest sales figures is that higher staples (food, gasoline etc) eat into the discretionary income of lower income groups in the States. For example, here is a breakdown from the 2006 census of how much each 'quintile' spends on energy.




Low 20%
Next 20%
Mid 20%
Next 20%
Top 20%
% Income
8
4.8
3.8
3.1
1.9
% Spending
4.1
4.2
4.3
4.0
3

source: Earnings View, Bureau Census

Moreover, this will rise with higher gasoline prices.


Product Mix Changing to Lower Margin Sales

The second issue is that these movements will affect the type of spending at the discounters. They can pass on the increased costs of food/gasoline but these are not high margin products. The result will be a drop in margins.  Indeed, at BJ Wholesale sales including gasoline rose 3.8% but excluding, they were only up 1.9% Discretionary spending on higher margin items appears to have slowed.

The third issue for the discounters is that unemployment remains high in the States and this will disproportionately affect lower income groups. Temporary staffing has been surging but permanent employment gains haven't yet kicked in. This makes employees nervous about opening up the purse strings.


Stocks to Buy?

I think these stocks may prove interesting as late cycle plays. Employment gains look like they are on the way and today's ADP report was particularly encouraging. Moreover any future drops in energy and food prices will benefit the discounters now that higher costs are being priced in by the market. The one blot on the horizon is the uncertain nature of the housing market. However, there will be plenty of time to monitor this in the next few months. These stocks are not a 'buy' just yet.

As for the wider retail market, I don't think these sales updates bear much relevance.