Will Wal-Mart Buy One of the Dollar Stores?

It’s a question many people are asking, but the answer seems pretty obvious.

Jul 15, 2014 at 6:20PM
Neighborhood Market


Hear that faint sound? It's people whispering about Wal-Mart Stores (NYSE:WMT) soon buying one of the dollar stores: Family Dollar (NYSE:FDO), Dollar General (NYSE:DG), or Dollar Tree (NASDAQ:DLTR). The dollar stores have been stealing share from Wal-Mart for years and there's nothing Wal-Mart can do about it, right? Wrong!

No big purchases 
I'm going out on a limb here, but it's a thick and sturdy limb: Wal-Mart will not buy one of the dollar stores. Why? Because there's no reason for Wal-Mart to acquire a company when it could steamroll that company.

For instance, Wal-Mart's small-box store Neighborhood Market (partially designed to steal share back from the dollar stores) delivered 5% comparable-sales growth in the first quarter year over year. Comparable sales refer to sales at stores open for at least one year. Comparable traffic increased 4%. And Neighborhood Market saw strength in all areas, including produce, meat, adult beverages, and pharmacy.

Additionally, Neighborhood Market stores performed well despite severe winter weather. And if you're looking at the big picture, Neighborhood Market has now delivered 46 consecutive quarters of comparable sales growth. But how does this impact the dollar stores?

The future landscape
Unless you're a Wal-Mart investor or someone who happens to live near a Neighborhood Market, it's likely that you have never even heard of Neighborhood Market. Therefore, you might not understand why it will become a threat to the dollar stores. On Wal-Mart's first-quarter conference call, it stated that it wanted to accelerate the roll-out of its small-box stores in order to complement its supercenters.

It's no secret that Wal-Mart is using its small-box stores to steal share back from the dollar stores. And Wal-Mart has its even smaller Wal-Mart Express to help.

In order for a retailer to take over territory and steamroll its competition (Wal-Mart has plenty of experience in this area), it must have capital (cash flow) to invest in the initiative. Wal-Mart has much more ammunition than the dollar stores:

WMT Free Cash Flow (Annual) Chart

WMT Free Cash Flow (Annual) data by YCharts

With that the case, Wal-Mart has more capability to fine-tune its small-box stores until it nails the concept and consistently steals share. Eventually, one (perhaps two) of the dollar stores would have to close locations and shrink in overall size, which would lead to Wal-Mart capturing those former dollar-store customers. Therefore, Wal-Mart has no reason to spend money on the acquisition of a dollar store.

The enterprise values for Family Dollar, Dollar Tree, and Dollar General are $7.07 billion, $11.84 billion, and $20.34 billion, respectively. Those are some hefty sums, even for Wal-Mart.

Additionally, remember that Wal-Mart upped its capex spending for the fiscal year in the U.S. primarily due to small-box store expansion. It now expects fiscal-year 2015 capex of $6.4 billion-$6.9 billion versus an earlier expectation of $5.8 billion-$6.3 billion. In other words, it doesn't sound like Wal-Mart has any interest in purchasing one of the dollar stores.

The dollar stores aren't firing on all cylinders right now, either. Family Dollar is currently dealing with poor margins and weak earnings, and Dollar General is dealing with upper management changes.

Even though it's not the biggest one, the one dollar store that appears to have the best long-term trajectory is Dollar Tree. This relates to the concept: it's actually a dollar store (everything there costs $1). 

This concept has worked out well for Dollar Tree. Consider its top-line growth versus that of its peers over the past five years:

WMT Revenue (TTM) Chart

WMT Revenue (TTM) data by YCharts

Now look at its return on invested capital. While the past year has been rough, it's obvious that upper management has been effective over the long haul:

WMT Return on Invested Capital (Annual) Chart

WMT Return on Invested Capital (Annual) data by YCharts

Despite Dollar Tree's success and business model, it's highly likely that Wal-Mart will remain focused on organic growth in the small-box store space. Wal-Mart is likely to follow the old adage: If it ain't broken, don't fix it.  

Final points
If Wal-Mart's going to make acquisitions, then they will likely be in the e-commerce space -- Wal-Mart has acquired 12 e-commerce companies over the past three years.

The bottom line here is that when it comes to the dollar stores, Wal-Mart will focus on stealing share and defeating its competition, not acquiring it. Given its capital advantages, Wal-Mart is more likely to succeed than not. It will not defeat all of the dollar stores, but if one (or two) fails, that will lead to new (or reacquired) customers for Wal-Mart. The end result is an advantage for Wal-Mart, which is an advantage for investors in Wal-Mart.

Small-box stores will lead to growth, but not this kind of growth!
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Dan Moskowitz 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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