Tuesday, January 15, 2013

The Outlook for the Dollar Stores

Christmas is the most important time of year for the retail sector, and the sales numbers for major players are starting to come in. The Christmas season usually sets the tone for the rest of the year in retail, so I thought it would be useful to do a quick round up and see if any discernible trends are developing. I’ve spilt some cyber ink on the sector in an article linked here, and its time (after only a few days) to start testing out some of the ideas. In this article I want to focus on the discount and off-price stores.

Discount Stores Discounting

The discount stores have been a fascinating subset of retail this year. They started the year with excessively optimistic expectations priced into them and have subsequently suffered a price correction going into the summer followed by a rally in autumn and then lately a sharp move downwards as disappointing news has followed.

In December Dollar General (NYSE: DG) updated the market and painted a picture of an increasingly price competitive market place with customers skewing towards buying lower margin goods; they also gave notice of how extreme the fluctuations in weekly sales were. Their big idea was to drop prices in order to keep market share and react to competition. This came after Dollar Tree (NASDAQ: DLTR) had disappointed the market with its same store sales growth, and with fewer (but larger) stores Dollar Tree has much organization to do. The only dollar store that had reported good same store sales growth was Family Dollar (NYSE: FDO) with a 4.7% increase last time around. However, the latest set of results revealed only a 2.5% increase for December and that was led by double digit increases in consumables.

Dollar Stores, Cigarettes and Alcohol

It is one thing to increase sales via increasing categories like cigarettes and food (as FDO and DG are doing in particular), but it is another thing when gross margins and earnings suffer as a result. FDO reduced its earnings forecast, and the other stocks fell in sympathy.  This sort of thing happens when the whole industry is expanding and cutting prices at the same time. More trouble ahead?

My take is that the US mass consumer has become extremely price and promotion sensitive. While the dollar stores were the early beneficiaries of this long term trend (and will continue to do well in my opinion), the fight back of the traditional grocers has started. The appeal of the discount stores is that a consumer can ‘trade down’ or shop there for certain items at discounted prices. However, it does not mean that they hold a monopoly over the customer. If she feels she can get that item similarly cheap at a traditional grocer then she will. Moreover, Family Dollar outlined its plan to spend $600-650 million on capital expenditures, much of which is to support new store openings. It’s a similar story with Dollar Tree and Dollar General.

Essentially, same store sales growth is slowing at the same time that the big three discount stores are committing themselves to rolling out new stores. I think it’s time for them to stop planning expansions and concentrate on squeezing sales out of their existing stores. When they do these things then I think they may start to look very attractive, because there are still good growth prospects here -- just not what the market had been expecting.

TJX Companies and Ross Stores

TJX Companies (NYSE: TJX) and Ross Stores (NASDAQ: ROST) both saw comparable sales grow more than forecast to 6%. The off-price retailers had reported good sales going into December but it’s never a good idea to rely too much on early indications. Every year, the trend towards later and later shopping at Christmas seems to exacerbate, and the growth of online shopping is skewing the comparisons even further.

Ross and TJX often get lumped together with the discounters (indeed I am kind of doing it too here!), but I think they have some subtly different prospects. They are both expanding their home ware sales, and this is a good thing with housing starting to show signs of recovery. Furthermore, Dollar General had difficulty in clothing in the quarter, and I take this to be a confirmation that clothing is not an easy category to compete in. It requires skills and experience that are not readily acquired. In addition, TJX has international expansion opportunities.

The Bottom Line

I think that, despite being attractive, the dollar stores are still worth avoiding but that a bifurcation in performance and market sentiment could develop in 2013 with relation to the off-price retailers. They are the ‘go to’ stocks for investors looking to invest in ‘trading down’ retail stocks. At least I hope so, because I happen to hold TJX!

No comments:

Post a Comment