Are These Better Times for Discount or for Upscale Retailers?

As economic uncertainty, particularly sluggish employment growth, continues to be a concern to retailers, those serving very different customer segments such as Dollar Tree, Target, and Tiffany are experiencing very different results.

Jan 14, 2014 at 3:53PM

The stock market indices may be perched at lofty levels, but the job market is still experiencing weakness. According to statistics released by the U.S. Department of Labor, 347,000 people left the workforce in December 2013, bringing the labor force participation rate down to 62.8%, the lowest level in 40 years.

People with poppin' portfolios feel a heady "wealth effect" that prompts them to spend more on discretionary goods, whereas those who continually send out resumes to no avail are scrambling to find ways to cut expenses.

Thus we might surmise that purveyors of luxury goods should be doing very well, and discount retailers should also have strong sales. That's why today we'll look at Dollar Tree Stores (NASDAQ:DLTR), Tiffany (NYSE:TIF), and Target (NYSE:TGT) to see how each is faring.

More proof that Americans love to find bargains
Dollar Tree operates discount variety stores in North America, with 4,953 stores at the end of the third quarter. The company is expanding at a furious pace, having added 323 stores in just the last 12 months.

Third-quarter results were superb, building on an equally successful second quarter. Revenue was up 9.5% compared to the third quarter of 2012. Growth would be expected because of the increased number of stores, but comparable-store sales were up a very nice 3.1%.

Chief executive Bob Sasser expressed his company's appeal very well: "[N]ew customers are finding Dollar Tree to be a part of their solution to balance their household budgets."

Efficient cost management allowed the sales increase to reach the bottom line. Both gross profit and selling, general, and administrative expenses as a percentage of net sales held steady compared with the same quarter last year. Operating income rose nearly 11% to $204.3 million.

One of the finer things in life is...profitability
Tiffany is primarily known for its fine jewelry, which accounted for 90% of net sales in fiscal 2012, but the company also sells timepieces, crystal, sterling silverware, china, and fragrances. The company has stores in the Americas, the Asia Pacific region, Japan, Europe, and the Middle East.

Tiffany's third quarter could definitely be described as sterling. Net sales worldwide increased 7% over the same quarter last year. Sales in the Americas were up slightly less, 4%, but the Asia Pacific region recorded a 27% increase while Europe was up a healthy 7%.

Gross margin increased a remarkable 2.6 percentage points to 57%, as product-cost pressures abated and the company saw the benefit of price increases from earlier in 2013. Selling, general, and administrative expenses were up 5% but were down 60 basis points as a percentage of net sales.

Earnings from operations as a result were up more than $36 million -- a nearly 31% increase over the previous year -- to $153.6 million.  

Danger, Will Robinson! There's been a data breach!
The big news coming from Target, which refers to itself as an upscale discounter, is the revelation that information about millions of its customers had been stolen. This includes payment card information and, as disclosed in a Jan. 10 press release, names, mailing addresses, and phone numbers.

This huge retailer -- with 1,797 stores in the U.S. and 124 in Canada -- faces the stiff challenge of restoring customer confidence. The negative effect of the data breach was immediate. The company's updated outlook is that comparable-store sales will be down 2.5% in the fourth quarter rather than the previous guidance of being flat.

In the third quarter, the company was already facing, as CEO Gregg Steinhafel said in the earnings release, "an environment where consumer spending remains constrained." Target's third-quarter comparable-store sales for U.S. stores were up a meager 0.9% compared to the same quarter last year. Total sales were up just 2% to $16.9 billion.

If you net out the negative effect on revenue from not having credit card revenue in the third quarter -- the credit card unit had been sold off -- sales were actually up a more respectable 4%.

In the third quarter, the gross margin percentage fell 30 basis points in the company's U.S. stores compared to the same quarter of 2012 due to seasonal markdowns. Selling, general, and administrative expenses were 70 basis points higher, as the company continued to step up its investments in technology.

Earnings before interest and taxes tumbled nearly 40% to $703 million, but the results actually weren't that bad because in last year's third quarter; the company recorded a $156 million gain on a receivables transaction. Even with that taken out, the decline was still 30%.

What we learned
Although Dollar Tree faces some formidable competitors in its niche, including Family Dollar Stores and Dollar General, the company should continue to be able to increase its store count because the waning recession has left behind a vast market of cost-conscious consumers who want to continue to maintain tight household budgets. Think of them as the "perpetually thrifty class."

There's more to Tiffany's success than the wealth effect encouraging U.S. consumers to buy luxury goods. In fact the company's comparable-store sales in the Americas were up just 1% in the quarter. The real story is how the Tiffany brand is gaining acceptance around the world. Of the 283 stores the company operated at the end of the third quarter, only 120 were in the Americas. Sixty eight stores were in the Asia Pacific region, 54 in Japan, 36 in Europe, and five in the Middle East.

For Target, the data breach brings up the serious question of if all of Target's customers will come back once the issue is resolved. The company admits the total cost of the data breach has yet to be determined.

From just an industry fundamentals standpoint, though, Target is an example of a company that would get a tremendous boost from rising employment and Americans returning to the work force rather than leaving it.   

My view of these three companies is that the best opportunities for retail investors right now are at the low end -- Dollar Tree -- and the upscale end -- Tiffany.

So who's losing in retail?
To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

Brian Hill has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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