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Initially, shares of Costco (NASDAQ: COST ) traded lower after reporting fiscal fourth quarter earnings. They quickly reversed throughout the day on Tuesday, however. Family Dollar (NYSE: FDO ) wasn't so lucky, which proves that retailers with a niche might perform best in this fragile consumer market.
What makes Costco great?
Costco has a unique business model: It operates membership warehouses where the company buys the majority of its merchandise directly from manufacturers, essentially cutting out the middle man. Costco sells in bulk but also at a lower price, thus fueling its rapid growth.
If you look at Costco's quarter, it only grew revenue by 1% year over year. However, comparable sales increased 5 %, showing that more consumers are becoming members and walking through its doors. In comparison, competitors Wal-Mart and Target are producing half the growth of Costco , right around the rate of GDP. This shows that consumers both seek the best deal and are attracted to Costco's niche of bulk.
Buying the niche
Family Dollar is clearly a dollar store. For the most part, however, it simply sells products like those you would purchase at Wal-Mart, but on a smaller scale. In its fiscal fourth quarter, customer traffic and average ticket prices were flat year over year . In addition, the company is guiding for comp growth of low single digits for full-year 2014, which is lower than most analysts anticipated. Basically, Family Dollar is nothing special, and its earnings serve as proof.
With all things considered, part of the government remains shutdown. Turmoil in Washington affects consumer confidence, and retail is ultimately affected. Historically, companies that save consumers money perform better in rough and uncertain markets. Costco's 5% comp growth is unprecedented for large retailers, but it also shows that pricing is important.
Therefore, Dollar Tree (NASDAQ: DLTR ) has to be attractive to investors and consumers in these uncertain times. The company has high-single-digit revenue growth and mid-single-digit comp growth, which are comparable to Costco. As for its niche, the company sells everything for $1. It also surprisingly has operating margins of 12.5 %.
In comparison, Family Dollar's operating margins are about half those of Dollar Tree. One of the reasons that it is trading lower after earnings is because management continues to warn of margin pressure. Dollar Tree sells many of the same products -- for a fraction of the cost – such as brooms, cleaning supplies, décor, and related items, and maintains its high margins while expanding at a rapid rate.
Finding the retail winners
In a market where consumers are seeking a deal, companies like Costco, Dollar Tree, and others like Five Below (NASDAQ: FIVE ) may be clear winners. Five Below operates much like Dollar Tree, but all products are sold at under $5.
Five Below is at a different stage of its business compared to Costco and Dollar Tree, but it is impressive nonetheless. Five Below's goal is growth, and in its last quarter it saw revenue growth of 35% while operating income rose 53% year over year .
Moreover, Five Below is only located in 19 states , giving it the ability to expand quickly. Because of this and its growth, Five Below might be a good retail investment despite a fragile consumer.
Costco, Dollar Tree, and Five Below are completely different companies, with each at different stages of the business cycle. Costco is large, established, and is most likely safe for long-term investors. Dollar Tree is also large, but produces less than 8% of Costco's total sales, though it is growing at a faster rate. Five Below is growing the fastest, and has the most near-term upside in terms of revenue. Despite the differences, however, all of the companies share a niche and save consumers money. This makes each attractive, and able to bear future drops in consumer confidence.
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