Have Dollar Stores Lost Their Charm?

After a year of solid growth, the dollar stores have run into tough times of late. Is this a sign of worse things to come?

Apr 27, 2014 at 8:00AM

The dollar stores are having a really bad time. Family Dollar (NYSE:FDO), which recently released its second-quarter results, is the latest casualty in a highly competitive retail environment, joining peers Dollar General (NYSE:DG) and Dollar Tree (NASDAQ:DLTR). A mix of factors such as cautious consumer spending, cutthroat pricing, and a subdued holiday period have led to weakness at all dollar stores.

It appears we are entering a phase in which the dollar stores will cut back on growth plans and focus on consolidation. Family Dollar was first out of the gate, announcing earlier this month that it will close 370 under-performing stores, slash its workforce, and cut prices. These signs are ominous and it seems there will be no respite for Family Dollar going forward.

An overcrowded space
During tough economic times, the dollar stores saw solid growth as consumers sought to save every penny. This led to rapid expansion, but now the number of stores in this space is making growth difficult to come by.

It is not surprising that Family Dollar is cutting its square-footage growth projections and looking to control costs after a 35% drop in earnings in the second quarter. The company's same-store sales were down 3.8% year over year in the previous quarter, marking the worst performance among peers. It now plans to slash prices for about 1,000 basic items in a bid to boost traffic. 

Peers doing better, but not by much
Family Dollar was the worst-performing dollar store last year, with a stock gain of just 3%, while Dollar General and Dollar Tree shares appreciated by more than 40%. But as things stand, an investment in any of these stocks doesn't make much sense.

Dollar General, the biggest chain of the lot, reported just 1.3% in same-store sales growth in the fourth quarter. Analysts had expected more robust growth of 4.5%. Dollar General's earnings forecast for the current fiscal year is another concern. The retailer expects to earn $3.50 per share, well below the $3.69 consensus. Since management isn't particularly confident about a bump in consumer spending going forward, it won't come as a big surprise if its same-store sales start declining.

Dollar Tree is headed in the same direction. Its revenue and earnings expectations for the current year are quite weak, and since it is the smallest dollar store of the lot, there's a risk of being crowded out by its competitors. Wal-Mart (NYSE:WMT) and Target are also focusing on smaller-format stores to increase sales, intensifying the competition in an already overcrowded area. 

Dollar Tree intends to open 375 new stores this year, but weakening comps and less-productive stores might derail the company's plans.

Target and Wal-Mart forays
This year, Wal-Mart plans to open up to 300 new Express and Neighborhood Market stores that are smaller than a typical supercenter. Same-store sales at these smaller stores were up 4% in the last fiscal year, turning in a better performance than its larger sites. This has encouraged Wal-Mart to invade the dollar store space in a more aggressive fashion, which is why it has doubled the planned buildout of these smaller-format stores in 2014.

Target is also testing its TargetExpress format, which will be a fifth of the size of its typical location. Target has leased out a location in Minneapolis for one trial, but it might build more such stores if it receives positive feedback. 

The bottom line
Family Dollar's store closures and job cuts could be just the beginning. if same-store sales keep dwindling, its peers might also have to resort to such measures. After a really good performance in 2013, the dollar stores have lost their charm; investors should stay away. 

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Harsh Chauhan 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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