Dollar Stores Are Still the Best Bet for Your Investment Dollar

If Wal-Mart (NYSE: WMT  ) sells everything you could ever need, why shop anywhere else? You can literally walk into any one of its 10,000 stores and buy anything from toothpaste to bed linens, motor oil, and cereal.

Enter the dollar store revolution. The likes of Family Dollar Stores  (NYSE: FDO  ) and Dollar General (NYSE: DG  ) have managed to capture serious market share thanks to the economic decline, drawing in customers looking to save money. And although the dollar stores really gained traction during the financial crisis, the question is, what helps these businesses keep their market share gains and move even higher?

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Retail giant Wal-Mart has a global reach, and it also operates the Sam's Club chain. But the issue is that Wal-Mart's are huge, and can be cumbersome when you only need a few items. The smaller dollar store format is much easier to navigate. Also, while Wal-Mart tries to cater to everyone, the dollar stores have carved out their niche. 

The dollar stores focus on lower-income customers. Specifically, Family Dollar notes that its typical customer is "a woman in her mid-40s who is the head of her household and has an annual income of under $30,000."

The dollar stores also generally get the majority of its revenue from consumables. 70% of Family Dollar's revenue are attributed to the consumables category, and consumables account for 74% of Dollar General's revenue. These items include paper and cleaning products, food, beverages and snacks, health and beauty products. These are items that will still be needed even after the economy rebounds. Also, both major dollar stores have turned to selling alcohol and tobacco, which should help them keep customers coming back.

Dollar General is the dollar store industry leader by store count, with some 10,600 retail stores across 40 states. Back in September, Dollar General posted EPS of $0.77, compared to the $0.69 in the same quarter last year. The growth driver was 11% growth in total sales and 5% higher same-store sales. After the good news, the stock saw a nice run up, and now Dollar General trades at a 10.5 EV/EBITDA multiple, which is a premium to Family Dollar's 9.7. However, in comparing the growth prospects, margins, and balance sheet, Dollar General doesn't deserve the premium valuation.  

Family Dollar has the superior gross margin, at 34% over the trailing twelve months, compared to Dollar General's 31.5%. In addition, Family Dollar has a less levered balance sheet. Family Dollar's debt to equity ratio is only 33%, while Dollar General's is at 55%. Family Dollar's superior balance sheet will allow the company to continue with its aggressive growth plans. 

Family Dollar has around 7,500 stores across 45 states, which leaves plenty of room to expand before catching Dollar General. The company plans to open nearly 475 stores in 2012, and another 500 in 2013. 

To top it all off, Family Dollar pays a 1.3% dividend that works out to be a 25% payout of earnings, whereas Dollar General doesn't pay a dividend.

Bottom line
I think the dollar stores will do a fine job of keeping, and even growing, market share. Analysts expect them to do just fine as well. In the $60 billion-dollar store industry Family Dollar sits in fourth, generating around $9.3 billion annually. Family Dollar has the most room to grow, and at 17 times earnings the stock appears to be great long-term buy. 

Dollar stores aren't the only companies revolutionizing retail
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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