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Dollar stores made a killing last holiday season.
In the fourth quarter of last year, Dollar Tree (Nasdaq: DLTR ) and Dollar General (NYSE: DG ) reported scorching comparable sales increases of 7.3% and 6.5%, respectively. Dollar Tree boosted its profit over those winter months too, by a strong 13%. And Dollar General rang up a nearly 20% jump in its own profit.
That showing compared favorably to that of other national retailers. Wal-Mart (NYSE: WMT ) had a 1.5% sales increase over the same period, which it pulled from a much larger base. And Target's (NYSE: TGT ) comparable sales increase of 2.2% didn't come close, either. Dollar Tree's and Dollar General's stocks were rewarded for this fantastic growth with increases of 60% and 38%, respectively, in 2011.
So the one-dollar question this holiday season is: Will it be deja vu all over again for these discounters? I think so, and here's why.
Of Christmases past
The catalyst for last year's big boost in dollar-store sales can be boiled down to one word: refrigerators.
Value shoppers were drawn into dollar stores last year as they looked to trade down from more expensive retailers and to do more discount shopping for everyday consumables. To capitalize on that trend, Dollar Tree added freezers and coolers to 380 of its stores in 2011 so that it could offer a wider selection of food. Dollar General followed the same strategy, and opened more of its "market" style stores while expanding cooler capacity to 500 of its traditional stores last year.
The companies invested major capital on the upgrades, and also risked lower profit margins by encouraging sales in the relatively less profitable consumables business. But the gambles paid off in spades. By promoting lots of repeat visits, the expanded store layouts boosted guest traffic numbers and helped average guest spending climb too.
So consumables helped turn these dollar stores into more frequent shopping destinations, without sacrificing profitability. Talk about win-win.
This time around
But can these retailers refrigerate their way to record profits again this year? Both discounters are banking on the trend to consumables continuing apace. Dollar Tree plans to add freezers and coolers to 325 more stores in 2012, nearly the same amount as last year. And Dollar General is in the middle of a similar push to continue boosting consumables capacity.
Even more encouraging to dollar stores, though, is the fact that the shopping buzzword for this holiday season appears to be "practicality." Consumers are feeling more confident, but are still very value-conscious in this economy. According to a recent NPD survey, many plan on spending more this holiday season, but they report discount stores and off-price retailers as increasingly their destination of choice.
As we saw last year, that's a favorable environment for dollar stores to operate in. And these retailers are ready to capture whatever seasonal boost they can. Earlier this month, for example, executive VP Todd Vasos at Dollar General said, "Getting a jump-start on the holidays is important to our customers, so we've filled our stores with seasonal items in October to help them prepare for decorating, giving and celebrating."
It's not all tailwinds for dollar stores, though. Higher gas prices and tough comparisons to last year's results make for a challenging second half of the year. Still, given the trends in consumables and holiday spending, it seems likely that sales increases will continue, despite the tough comparisons to last year's record results.
They may be set for another great business year, but how do the dollar stores look as investments? With P/E ratios of around 18, both Dollar Tree and Dollar General look a tad expensive relative to Wal-Mart and Target -- which can be bought for around 15 times trailing earnings. But given the growth these discounters have been booking, that premium seems warranted.
And even though their stocks have trounced the S&P since 2008, more recently they have underperformed their larger competitors:
Of this group, I think Dollar Tree would make the best investment right now. As the only discounter that focuses exclusively on the $1 price point, the company has a simple and compelling value proposition. With increasing consumables and holiday spending, it also boasts a clear path to continued growth for this winter, and beyond. And best of all, shares are well off their 52-week highs thanks to what looks like short-term worries to me. The company had a great holiday season last year and looks set to put on a repeat performance in 2012.
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