Is Investing in This Dollar Store Worthwhile?

It's difficult to believe that even dollar stores witnessed lower than expected sales in the so-called peak season for the retail industry. However, all you have to do to see the truth is look at Dollar General's (NYSE: DG  ) fourth-quarter results. Its numbers were below the Street's expectations, and its outlook was dismal. This led to a sharp decline in its share price.

A host of external factors
Although revenue surged 6.8% to $4.5 billion, it failed to meet analysts' estimate of $4.6 billion. However, earnings met the expectation of $1.01 per share, a jump of 4% over last year. The key factor that hampered Dollar General's sales during the quarter was extreme weather conditions, which resulted in store closures. Heavy snowfall also kept consumers away from stores. Also, lower consumer confidence forced people to spend less.

Moreover, government regulations, which reduced the benefits of food stamps, pinched U.S. shoppers' pockets further. Hence, there were a large number of factors affecting the retailer's top line. Another key reason for lower than expected results was the heavy promotional environment, which meant stiff competition for the retailer.

Nonetheless, Dollar General managed to post better fourth-quarter numbers than its peer Dollar Tree (NASDAQ: DLTR  ) . Dollar Tree's quarter was a lackluster one wherein its revenue dropped 0.5% to $2.2 billion. Also, its comparable store sales grew by 1.2%, slightly lower than that of Dollar General. Earnings jumped a meager 1% to $1.02 per share, below the estimate of $1.05 per share.

Dollar Tree has been focusing on private-label products for quite some time now since they provide higher margins and are quite popular with customers. Still, its margins shrank by 100 basis points, clocking in at 36.9%. Another point of focus for this retailer is the frozen foods segment, which has become quite popular among customers as demand for refrigerated items has increased. Hence, Dollar Tree has been expanding this segment by adding such items to another 42 stores, and the company plans to make such products available in another 320 stores during this year.. Despite such efforts, Dollar Tree was unable to outperform Dollar General.

Positive factors that helped
Although Dollar General had to deal with quite a number of problems during the holiday quarter, there were some factors that worked in the company's favor. For example, 650 new stores added during the fiscal year pushed sales higher.

Even same-store sales, which exclude the effect of store openings during the period, increased 1.3% during the fourth quarter. More transactions and higher customer traffic drove same-store sales higher.

The inclusion of tobacco products has also played a very important role in Dollar General's growth. Although they provide lower margins, tobacco products attract a large number of customers to stores; people who visit the dollar store for buying tobacco also buy other products, which increases store sales. In fact, it was seen that 68% of tobacco sales include at least one more item. Excluding tobacco sales, same-store sales would have been flat for the quarter.

Looking forward
A key point of concern for investors was the dull outlook provided by the retailer for the current quarter. It announced a sales increase in the range of 7% to 8% along with same-store sales growth of 2% to 3%. On the other hand, analysts were expecting the top-line growth to be at 9.8%. Also, earnings guidance stood between $0.72 and $0.74 per share, whereas analysts were expecting it to be $0.81 per share. The bottom line estimates were affected by new health care regulations, which will result in higher costs.

However, the company has a number of strategies to combat the economic pressures and lure customers to its stores. In addition to opening new, more convenient stores, it has included better brands, which should attract more people. Also, it has started providing free delivery services for online orders, which should help in boosting sales from the e-commerce channel.

Additionally, the retailer is remodeling its smaller format stores in order to make them more productive. The program is called "Lifecycle remodeling," which remodels stores that should have been relocated or expanded, but were not done. It includes remodeling the stores and stocking only those products that sell frequently.

This strategy of having smaller stores is similar to that of retailer Wal-Mart (NYSE: WMT  ) . Wal-Mart has resorted to opening smaller format stores that weigh less on the bottom line. This strategy not only reduces costs, but also helps make Wal-Mart available in urban areas where it is difficult to own a large space. Therefore, Wal-Mart's customers have easy access to its stores and can walk into any of the nearby stores even for small needs. Although Wal-Mart felt the pinch of bad weather conditions, with comparable store sales declining 0.4% during the latest quarter, same-store sales at the smaller neighborhood stores grew 5%. Hence, opening smaller stores proved to be beneficial for Wal-Mart.

Final verdict
Dollar General is not the only one to witness tough economic conditions. Other retailers as well as its peers are facing similar problems. However, the winter season has passed, and the spring season should bring better shopping conditions. In addition to that, Dollar General's strategies look good to go. But weak quarterly numbers and a poor outlook make me doubtful about its future prospects. I would rather wait for the right time to jump into this dollar store.

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