Most people don't like to consider themselves as "close to poverty," but a new study estimates that nearly half the population is living paycheck to paycheck, which means they aren't far from it.
The Corporation for Enterprise Development, or CFED, recently published the 2014 Assets & Opportunity Scorecard. It shows that despite an improving economy, poverty rates remain high; 44% of the country lacks the savings needed to make it through a job loss or medical emergency. This may be the reason why discount retailers like Dollar Tree (NASDAQ:DLTR) and Dollar General (NYSE:DG) did so well in the third quarter -- more people have started using dollar stores to purchase groceries and other consumables.
Indeed, Dollar Tree had same-store sales growth of 3.1% for the third quarter and attributed the growth to an increase in customer traffic. The company is actively trying to increase the number of stores that can sell frozen food. As of Nov. 2 the company had 3,110 stores which stocked frozen and refrigerated merchandise, compared to 2,470 the previous year.
Dollar General had record performance in the third quarter with same-store sales growth of 4.4%. Like Dollar Tree, Dollar General credits its success to increases in customer traffic from the roll-out of more frozen and refrigerated merchandise. In 2013, the company expanded coolers for refrigerated and frozen foods in 1,700 stores and converted certain locations to Dollar General "Plus" stores, a slightly larger format with significantly expanded space for frozen and refrigerated food.
Rough times for discount retail
Howard Levine, the CEO of Family Dollar Stores (NYSE:FDO), is the son of the founder who saw the start of the first food stamp program back in 1939. Frozen food doesn't have high margins, but it increases the frequency of customer visits. Many of those people are on food stamps which were cut back in November. The Farm Bill, approved by the Senate on Feb. 4, cut another $8 billion from the budget.
At its peak, the original food stamp program included 4 million people. In 2013, the program had over 47 million participants, which is roughly 15% of the population. Levine discusses the effect income inequality is having on his company on the last earnings call:
Over the last 2 years, I think we've seen a growing bifurcation of households. Higher-income households, who have benefited from market gains, better employment opportunities or improvements in the housing markets, have become more comfortable and confident in their financial situation. But our core lower-income customers have faced high unemployment levels, higher payroll taxes and more recently, reductions in government assistance programs. All of these factors have resulted in incremental financial pressure and reduction in overall spend in the market.
Food stamp cuts make matters worse
In 1943 the food stamp program cost approximately $262 million,while today it costs $80 billion. Clearly, any cuts to the program will impact discount retailers that sell food and accept food stamps. Even those discount retailers that don't sell food will be affected by a low-income customer with fewer dollars to spend.
Dollar General and Dollar Tree report earnings on March 24 and Feb. 26 respectively, but Wal-Mart Stores (NYSE:WMT) and Family Dollar (NYSE:FDO) have already provided us with a glimpse into the world of discount retail after food stamp cuts. The results don't bode well.
Family Dollar reported a decrease in same-store sales growth of 3% on the last earnings call. Bernard Sosnick, a research analyst for Gilford Securities, asked the CEO if he thought the drop in traffic was due to the recent reduction in food stamp, or SNAP, benefits. The CEO responded with the following comment:
...clearly, a reduction in SNAP benefits is not a positive. SNAP benefits have increased substantially over the last several years. And with that reduction, it certainly will have an impact on our challenged consumer.
On Jan. 31, Wal-mart warned investors that it had underestimated the effect of SNAP cuts on sales. As a result, the company believes earnings will come in on the low end of guidance. It's important to note that Wal-Mart came into the fourth quarter with an increase in earnings guidance, which suggests that the impact of the cuts was much larger than expected.
The Foolish bottom line
Reductions in SNAP benefits have already caused the nation's largest discount retailer to decrease earnings guidance and the new Farm Bill promises an additional $8 billion in cuts -- the pain is hardly over. Those retailers that counted on food stamps for sales growth must come up with additional revenue streams in order to meet earnings guidance this year. Even those retailers that don't accept food stamps, or sell food, will be affected as customers have less disposable income. It's not a question of if discount retailers will be affected, it's a question of how much and how long.
C Bryant 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.