Is Dollar General the Best Buy in Discount Retail?

Deep-discount retail stores continue to gain market share as more consumers buy into these brands. But investors should choose carefully in a sector with uneven performance.

Jun 9, 2014 at 10:41AM

Deep-discount retail chains are growing in popularity with bargain-conscious consumers. The three feature players in this sector are Dollar General (NYSE:DG), Family Dollar (NYSE:FDO), and The Dollar Tree (NASDAQ:DLTR). Dollar General continues to lead the sector, as evidenced by its latest financial report. However, investors should choose carefully given the uneven performance of theseretailers.

Dollar General's first-quarter profits rise
Dollar General continues to perform better in overall terms than its rivals, which are struggling with weak consumer demand. The company's results are improving even as margins tighten. And management attributes the latter to costs connected with adding better-known brands to its existing floor space while opening new stores.

For the first quarter, profit rose by 1.1% as Dollar General posted generally higher sales. While same-store sales climbed by 1.5%, this was below Dollar General's March guidance, which anticipated same-store sales growth of 2% to 3%. Some investors might see this as a yellow flag, but management blamed low growth on the long and harsh winter.

The sales miss "reflected the challenges of unfavorable winter-weather, heightened competition and the current economic environment," said Dollar General's Chief Executive Rick Dreiling.

But the question remains as to whether heightened competition and the economic environment will remain a wet blanket on comps going forward. Dollar General seems poised to handle the first hurdle as it continues to open new stores that feature better-known brands, however.

In sum, for the quarter ended May 2, the company reported earnings of $222.4 million, or $0.72 per share, up from $220.1 million, or $0.067 a share, for the year-ago period. The company also continued its share repurchase program and distributed $800 million by repurchasing 14.1 million shares in the quarter.

Investors know that share repurchases tend to support earnings. But long-term earnings growth requires better sales and revenue growth in the coming quarters. In this regard, Dollar General expects total sales to increase 8% to 9% for the 2014 fiscal year with same-store sales growth of 3% to 4%. Finally, the company expects diluted EPS in a range of $3.45 to $3.55.

"Looking ahead, we are confirming our sales and EPS guidance for the year, and we are confident that we have the right strategies to drive long-term shareholder value," said Dreiling.

Family Dollar's comps tumble in the second quarter
Family Dollar has been a good-news, bad-news story recently. This week, the company announced that its Board of Directors has declared a quarterly cash dividend of $0.31 per share on the common stock. The company will pay the dividend on July 15 to shareholders of record on June 13, 2014.

But this sunny story comes on the heels of the company's poor showing when it posted second-quarter results highlighted by a tumble in comparable-store sales of 3.8%. And that's gonna leave a mark. Family Dollar also reported diluted EPS of $0.80 with a drop of $0.05 because of the rough winter weather.

"Our second quarter results did not meet our expectations," said Howard R. Levine, Chairman and CEO. "We have initiated an in-depth business review to identify opportunities to strengthen our value proposition, increase operational efficiencies and improve financial performance."

Family Dollar's review plan is aimed at identifying opportunities to enhance value for consumers while improving financial performance. The financial report notes that "the company is executing a series of immediate strategic actions" to reach this goal. These actions include slashing prices in order to boost sales, closing underperforming stores this year, and opening fewer new stores in 2015.

And here's the kicker: Family Dollar will record an estimated $85 million-$95 million restructuring charge in the second half of 2014 related to reductions in force and store closures. The restructuring charge was not included in the company's prior guidance.

In other words, the challenges of heavy weather and competition are being amplified by the strategic action plan, so investors should remember the simple maxim: caveat emptor.

Dollar Tree grows in the shadows
The best thing to like about Dollar Tree is the relative bargain price of the company's shares compared to those of its rivals. The deep-discount chain recently posted solid first-quarter results highlighted by same-store sales growth of 2% coupled with 7% growth in net sales.

In other words, the retail chain's sales were not hampered by the heavy winter weather and it is meeting the challenge of its rivals while persisting in a prolonged weak economy. Like its rivals, Dollar Tree has a stock repurchase plan in play, which supported EPS growth of 13.6%.

Foolish bottom line
Family Dollar obviously will be pulling back as it restructures. Meanwhile, Dollar Tree continues to grow and may capture some of the falling leaves from Family Dollar. Finally, Dollar General has a long-term plan to grow its brand by offering consumers higher-quality products while continuing to open new stores. 

In sum, investors should choose carefully, but Dollar General and Dollar Tree are poised for future growth. But the key challenge will be for each of these stores to retain customers if and when the economy improves enough to give consumers more purchasing power.

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Kyle Colona 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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