Are These 3 Retailers a Good Deal in a Subdued Retail Environment?

Costco, Kroger, and Dollar General have continued to do well in a tepid environment, and this makes them worth a look.

Jan 21, 2014 at 1:40PM

A tight economy and the increasing interest of customers in value and convenience is driving them to low-cost retailers like Costco Wholesale (NASDAQ:COST), Kroger (NYSE:KR), and Dollar General (NYSE:DG). But even if the economy comes out of slumber, consumers aren't going to flee to other retailers all of a sudden, which means that the companies above can continue performing well.

Costco's moves
According to a First Research report, warehouse clubs and superstores are expected to grow at a good pace this year and next. This is a good growth driver for Costco, which is the fourth-largest retailer in the world, with annual revenue exceeding $100 billion. It is not surprising that Costco opened 13 new stores in the first quarter of fiscal 2014, and it has plans to open a total of 30 new stores in fiscal 2014, expanding for the first time into Spain.

Costco's growth engine is also based on getting new members and managing to retain them, since most of the company's profits come from membership fees. Companywide membership signups were 17% higher than the same period a year-ago due to more store openings versus last year. This is where the strategy of opening new stores is important, as it brings in new members. The company did well even in retaining members by registering a 90% renewal in the U.S. and Canada and around 87% worldwide.

Top-line growth through new openings isn't the only thing that Costco has its eyes on. During the first quarter, comparable-store sales increased 3% as compared to the same quarter a year ago. On the heels of positive comps and new openings, first-quarter sales climbed 5% over last year to approximately $24.5 billion.

As a result of revenue and membership growth, Costco's net income rose from $416 million last year to $425 million this year in the first quarter, representing earnings per share of $0.96. This fell short of the $1.03 per share expected by analysts. Though disappointing, the shortfall in earnings was more due to declines in the gross profit on gas, unfavorable currency movements, and an unusual step-up in stock-compensation expenses.

Dollar General: superior margins
With stiff competition in the retail space and consumers always bargain hunting, both Costco and Kroger operate on razor-thin profit margins as compared to Dollar General, which is the clear margin leader as shown in the chart. This is because the price on a per-unit basis is typically higher at a dollar store than at a discount store like Kroger, but the number of units sold is lower, and hence, Dollar General is catering to consumers with a smaller shopping basket or those with no credit cards.

DG Profit Margin (Quarterly) Chart

Dollar General profit margin (quarterly) data by YCharts

Dollar General, with a store count of 11,000-plus spread across 40 states, has been growing at a rapid pace, with square-footage growth for 2014 expected to be in the 6% to 7% range. For fiscal 2014, it plans to open around 700 new stores and remodel or relocate around 525. In 2013, until its third quarter, it opened 577 new stores and relocated or remodeled 534 stores.

On the heels of a 4.4% comps gain, new store openings, and remodels, Dollar General reported revenue growth of 10.5% versus the prior-year quarter to approximately $4.4 billion. The consumables segment has been the star performer, and October Nielsen data indicates that Dollar General continued to gain market share on consumables over four-week, 12-week, 24-week and 52-week periods. Since 2007, Dollar General has added 3,000 stores and has almost doubled its revenue.

Opportunity for Kroger
While Costco and Dollar General have been expanding primarily on the back of new store openings, Kroger has been looking at acquisitions as a growth driver. For example, last July, Kroger announced the acquisition of Harris Teeter Supermarkets in a deal worth $2.4 billion. Looking forward to 2014, Kroger expects that excluding the benefits accruing from this acquisition, earnings will grow in the range of 8% to 11%. The Harris Teeter acquisition is in the midst of an FTC investigation and is expected to be completed by the end of fiscal 2013.

In its third quarter, the company reported its 40th consecutive quarter of comps growth, and this is commendable--especially if we look at the general softness in the retail sector due to subdued consumer spending. However, on the back of 3.5% comps growth and a loyal customer base due to its customer-first strategy, Kroger's revenue for the quarter increased 3.2% over last year to $22.5 billion.

Kroger envisages growth potential going forward, as it currently commands only 50% of what households spend on all items that are on Kroger's shelves. Hence, with a customer-centric strategy and scope of increasing market share, Kroger is also looking well-positioned for the future.

Bottom line
While Costco has seen robust increases in memberships in recent times, Dollar General is looking to capture more customers by expanding stores. Kroger, one of the biggest grocery chains in the U.S., is looking at acquisitions to increase revenue and has seen good growth in revenue and comps. Also, a dividend yield of 1.7% makes Kroger a good deal.

All three retailers have different strategies for growing their businesses and providing the best that they can to customers, making them good options to invest in.

Fool contributor Shirish Mudholkar has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. 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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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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