The Crack in Dollar Tree's Armor


Source: Wikimedia Commons.

Dollar Tree (NASDAQ: DLTR  ) continues to impress each quarter with robust sales, same-store sales growth, and diluted earnings-per-share increases. This dollar chain credits in large part a budget-conscious and cash-strapped consumer filling up its stores looking for bargains. Further growth seems like a no-brainer, but there are two things to watch for that could become speed bumps on its road to further riches.

Opportunity is still vast
Dollar Tree believes the market can hold another 60% increase in its stores while simultaneously growing sales in each store more. It is finding ongoing sustainable success by adding perishable food, especially refrigerated and frozen goods, which Family Dollar Stores (NYSE: FDO  ) and Dollar General (NYSE: DG  ) have also seen success with.

The company also still owns a tiny chain of non-dollar stores called Deal$ that will help it penetrate the urban, higher-price-point market as it expands in this area. Deal$ does not have the $1 price tag restriction that the Dollar Tree chain has, and it allows Dollar Tree to compete with Family Dollar Stores and Dollar General directly within cities.

Opposite economic reactions
One difference that separates Family Dollar Stores and Dollar General from Dollar Tree is the companies' attitudes about the economy. Howard Levine, Chairman and CEO of Family Dollar Stores, said in its second-quarter earnings release that "a more promotional competitive environment and a more financially constrained consumer" is hurting Family Dollar Stores.

Similarly, Rick Dreiling, Chairman and CEO of Dollar General, mentioned in its first-quarter earnings the "heightened competition and the current economic environment." He explained that these factors were challenges for Dollar General.

It is this poor economic environment that is driving some people away from Family Dollar Stores and Dollar General over to Dollar Tree, where everything is $1 or less. What could possibly go wrong going forward for the company?

Source: Wikimedia Commons.

A spike in fuel prices
The savings from shopping at a dollar store are only good relative to the cost to get there, especially for truly budget-conscious customers. If nothing else, the sheer short-term shock of fuel price spikes has consumers making fewer but bigger trips to the stores and therefore making fewer of the impulse purchases that dollar stores depend on.

Flash back to 2005. This was the largest percentage gain in fuel prices since the 1970s. It was also the first year, and the last, of negative same-store sales for Dollar Tree. For the first quarter of 2005, same-store sales plunged 3.7% compared to guidance of flat sales given halfway through the quarter.

Bob Sasser, CEO of Dollar Tree, stated at the time, "Our customers have experienced and continue to feel the impact of higher fuel costs." In the company's report for the second quarter of 2005, regarding these negative same-store sales, Sasser stated, "Our customers continue to feel the strain of rising fuel costs, and they are responding with fewer shopping trips."

Same-store sales continued to suffer in the third quarter, only to finally start rebounding in the fourth quarter as consumers adjusted and became somewhat numb to the higher fuel prices.

Is a good economy Dollar Tree's enemy?
Remember that Dollar General and Family Dollar Stores cite the negative economy as a challenge, while Dollar Tree cites it as an advantage. It then stands to reason that an improving economy that is felt by the lower and middle classes could also be a negative headwind for Dollar Tree. Sasser made an interesting statement during the company's recent conference call. He stated:

"And then the talks about ... the unemployment issues, it remains high, there is always concern about ... how long the benefits are going to last until I get a job, so it's a worried and concerned consumer. I believe that we are well positioned as you can be."

"As well positioned as you can be" isn't exactly encouraging. It's possible that things are so good now for Dollar Tree that they can only get worse from here. 

Again, flash back to 2005 and even 2004. These two years saw the strongest growth in the economy in the 14 years since the tech bubble burst in 2000. They were also the two worst years in same-store sales growth for Dollar Tree, with just a 0.5% increase in 2004 and a 0.8% drop in 2005.

Coincidence? Perhaps, and we know that the company's results in 2005 were at least partly due to fuel prices. However, it also makes sense that more discretionary purchasing power from consumers might mean they are less budget-conscious and more likely to get household items at more traditional retail spots.

Dollar Tree should continue to grow and prosper in the long term. Just be wary that fuel prices or an overheated economy could create a temporary timeout for Dollar Tree's success. On other hand, it could prove to be exactly what Family Dollar Stores and Dollar General need to get their own success going again.

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