Where Millennials' Money Is Going Will Shock You

Millennials (ages 13-33), 80 million of them, aren't spending wildly like one would expect. Instead, they are licking the wounds from student-loan debt, their parents' difficulties in the recession, and challenges finding jobs. This triple whammy has led them to a Great Depression mind-set when it comes to spending.

According to retail industry analyst Marshal Cohen of The NPD Group, "Millennial shoppers have the lowest shopping conversion rate (turning a store visit into a purchase) because they are the most selective as well as the most economically challenged." The actual conversion rate for millennials is only 57% compared to boomers' 69%.

Who benefits from the new frugalistas?
Believe it or not, NPD concludes the dollar stores are among the biggest beneficiaries of this new youthful frugality. Dollar stores and secondhand stores have the highest shopping-conversion rate among millennials of all of retail. Goodwill isn't publicly traded, so off-price channels like Dollar Tree Stores  (NASDAQ: DLTR  ) , Five Below (NASDAQ: FIVE  ) , and Family Dollar Stores  (NYSE: FDO  ) are a starting point for due diligence.

Five Below is a chain of 258 specialty discount stores in 18 states with merchandise aimed at teens and college students, the younger of the millennials. Everything is priced at $5 or less. It is the smallest of these three companies but enjoyed the highest EPS growth rate over the last five years of 31.4%. It also sports the highest trailing earnings multiple at 46.60, more than the industry average of 27.40.

The company surprised and beat when it reported second-quarter results on Sept. 8. When it reported in June, it guided for the second quarter for a 4%-5% increase in comp sales and an increase in net sales from $95.6 million (a 33% increase year-over-year) in the first quarter to a range of $112 million to $114 million. It handily beat  comp sales guidance with a 6.6% rise and net sales also came in higher than guided at $117.1 million. 

The company debuted with a July 2012 IPO and as a Nasdaq newbie. There is still plenty of pessimism, with 19% short interest. However, looking at the company's revenue and earnings charts below, it seems it is well on the way to improve numbers this year.

Revenue (Trailing-12 Quarters)

Earnings per share (Trailing 12 Quarters)

It also seems undervalued for its price-to-sales ratio at 0.8. It has a  trailing earnings multiple at 19.6, still higher than Dollar Tree at 18.8, which is lower than the industry average of 20.0.

Family Dollar still raising yield
In comparison, Family Dollar's growth was 19.3% in the last five years. That growth is expected to slow to 11.3% over the next five years. However, Family Dollar is a Dividend Aristocrat, having consecutively raised its dividend for over 36 years. The yield now stands at 1.5% at a reasonable payout ratio of 24%. The dividend growth rate over the last five years is 12.8%

Family Dollar may be the largest in number of stores at 7,600 in 45 states, but Dollar Tree is catching up with 4,600 stores in 48 states. Plus it is opening 345 new stores throughout 2013.

Family Dollar beat expectations when it last reported, helping the stock rise. What helped boost the share price even more has been rumors of a private equity or rival Dollar General buyout of Family Dollar. The company could be in play again after Nelson Peltz's pact expired in August,making an acquisition easier. However, as Scott Mushkin of Wolfe Research Securities told Bloomberg, "Family Dollar's business is just very average right now, so I think that's why this fantasy of either a private-equity bid or Dollar General taking them out is being rekindled."

Maybe he thinks business is very average, but the company looks on track to beat last year's numbers as seen on this chart.

Revenue (Trailing-12 Quarters)

Earnings per Share (Trailing 12 Quarters)

$2 billion in sales, one dollar at a time
Dollar Tree may be the sensible compromise of these three businesses. It has the highest net profit margin of 8.4% to Five Below's 5.1% and Family Dollar's 4.1%. The company hit a landmark of $2 billion in sales in 2012.

In a CNBC showdown on Dollar Tree versus Family Dollar, Marc Lichtenfeld of The Oxford Club called Dollar Tree "a clear winner,"  noting with only 40% the number of Family Dollar stores, Dollar Tree generates 60% more cash flow from operations and Family Dollar has been "free cash flow negative for the past two years."

FDO Free Cash Flow Chart

Family Dollar free cash flow data by YCharts

Dollar Tree's best strategy for growth aside from opening new stores is offering frozen and refrigerated food products. It had this in roughly half of its stores in 2012 with 475 more stores getting the appropriate fixtures this year.It is important because SNAP program (better known as food stamps) revenue can be significant, with Americans receiving $24 billion annually in food assistance.

CEO Bob Sasser announced Canadian expansion ambitions from 140 stores currently to a possible 1,000 stores. By the end of 2012, the company had rolled out 194 new Deal$stores, which offer items at a discount but at more than a dollar. Sasser said it's early days, but, "Awareness of the Deal$brand is growing and the concept is building momentum."

Looking at the revenue and earnings chart for Dollar Tree, it is the prettiest of the bunch. Barring a black swan event, it looks like it will handily surpass last year's numbers.

Revenue (Trailing-12 Quarters)

Earnings per Share (Trailing 12 Quarters)


Clearly Dollar Tree is my favorite for its cash flow from operations and higher margins. Family Dollar is certainly worth a second look for a dividend investor who wants a stable growing yield. Just don't buy it as a takeout candidate.

Train 'em up young
Fortune magazine bemoaned the decline of the dollar store after Dollar Tree missed expectations by a penny when it reported on August 22. However, I think the dollar stores still have plenty of upside as this new millennial generation gets into the dollar-store habit in their youth.

Five Below, the dark horse, is small and speculative, but as a teen off-price retailer for the youngest millennials it could be worth a small investment. 

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