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3 Stocks to Capitalize on the New Culture of Frugality

By Mark Lin – Mar 12, 2014 at 3:34PM

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If you are looking for stocks benefitting from the latest consumer trends, companies serving the needs of bargain hunting customers might also be the ones to consider for your stock portfolio.

Source: Family Dollar

While the U.S. stock market rose by as much as 27% in 2013, the average Joe didn't really benefit. The real average hourly earnings for all employees rose only 0.4% year-over-year in December 2013. With the U.S. economy and employment rates having not fully recovered from the global financial crisis, a new culture of frugality has set in. This has in turn ushered in a new generation of budget-conscious consumers. Companies that are well positioned to benefit include dollar store operator Family Dollar (FDO.DL), off-price retailer TJX (TJX 0.47%), and Denny's (DENN -0.45%).

Source: TJX

Making your dollars count
The biggest validation of the dollar store format comes from retail giant Wal-Mart. In February 2014, Wal-Mart announced that it now expects to add about 270 to 300 small stores in 2014, double the October 2013 forecast of between 120 and 150 stores. A smaller dollar store operator to consider is Family Dollar. It boasts a long history in the U.S. retail scene, having started its first store in Charlotte in 1959. It now has a retail footprint of more than 8,000 stores in 46 states.

More than half of Family Dollar's customers earn less than $40,000 per year. They are often dependent on government assistance and are regular users of discount coupons. This suggests that Family Dollar's offerings of nationally recognized brands and quality private label products at below $10 are a natural draw for its core customers.

Famly Dollar's recent financial results has been disappointing, with negative 2.8% comparable store sales growth and a 1.9% decline in EPS in the first quarter of 2014. It is implementing changes to improve its operating performance which should benefit its share price in the long term, however.

One of the initiatives is the reduction in middleman costs through increased direct sourcing. It is hoping to source 13% of its annual purchases directly from manufacturers by 2015, compared with a corresponding ratio of 4% in 2012. Another initiative relates to increased private label sales. Family Dollar added 500 new private brand consumables SKUs (stock keeping units) in 2013. As Family Dollar gets its act together again, it should see its customers returning.

Brand-name merchandise at reduced prices
A typical customer at off-price retailer TJX is a fashion- and value-conscious female consumer between the ages of 25-54; she likely belongs to the middle to upper-middle income bracket. TJX draws in these customers because it's able to offer similar branded merchandise to what high-end department and specialty stores sell at significantly lower price. TJX's sourcing strategy and capabilities play a big part in its low price positioning.

It typically buys pre-season cuttings and "unwanted merchandise" such as manufacturer overruns and order cancellations; this acquisition strategy cost less. By virtue of its significant buying volumes (2014 sales of $27 billion) and supplier diversification (16,000 vendors from 60 countries), TJX is also able to drive hard bargains for its goods.

The "same-for-less" strategy seems to have gained resonance with consumers shopping for apparel. In 2012, while U.S. apparel sales grew by only 4%, the country's five largest off-price retailers saw their revenues increase by 11% instead. TJX's financial results reflect this industrywide trend as well. It registered a EPS growth of 15% in fiscal 2014 and planned to increase its dividend by 21%.

TJX's long term financial record is even more impressive. Notwithstanding the 2001 dot-com bubble and the 2008-2009 Global Financial Crisis, TJX has delivered positive same store sales growth for 18 straight years. Similarly, it has increased its dividends every year a CAGR of 23% over the same period.

Source: Denny's

America's diner with lower price points
Denny's, a casual dining restaurant chain which call itself "America's Diner," has worked hard to live up to its billing. With average check sizes at fast casual restaurants and quick service restaurants (QSRs) averaging $7.40 and $5.30 respectively in 2013, Denny's has managed to stem the loss of market share associated with diners trading down to offerings with lower price points. Its "$2, $4, $6, $8" value menu has been available at all of its stores since 2010. Denny's is constantly refreshing its value menu, and new offerings include the $4 Baja Quesadilla Burger and the $8 Parmesan Skillet.

Denny's customers responded positively to Denny's introduction of its value menu. While Denny's experienced two consecutive quarters of negative same store sales growth exceeding 6% in the first and second quarters of 2010, it managed to stem the decline in same store sales with greater customer acceptance of its value menu. Since the national roll-out of the value menu, offerings from the value menu accounted for 19% of all customer purchases and negative same stores growth was such milder at negative 2% in the subsequent three quarters.

In January 2011, Denny's launched its "America's diner is always open" marketing campaign, which highlighted its value menu offerings among other things. Following the campaign, Denny's witnessed a 25% increase in orders from the value menu and registered positive same stores growth in every quarter since the second quarter of 2011.

Foolish final thoughts
With bargain hunting becoming a new national hobby, companies like Family Dollar, TJX, and Denny's are the key beneficiaries. All three companies cater to the needs of penny-pinching customers.

Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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