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Increasing Competition Could Lead to Trouble for This Dollar Store

By Harsh Chauhan – Mar 15, 2014 at 7:00AM

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Will Wal-Mart and other dollar stores throttle this company's growth?

Dollar Tree (DLTR -2.29%) is facing a lot of heat. Things haven't improved for the discount retailer, as its recent fourth-quarter results and the accompanying guidance show. The company continues to struggle due to a variety of reasons. Moreover, as rivals Dollar General (DG -1.74%) and Wal-Mart (WMT) continue their expansion spree, Dollar Tree could be in for troubled times ahead.

Short-term headwinds
Dollar Tree missed consensus estimates in the previous quarter due to a shorter holiday selling season and bad weather. Management claims that 700 store selling days were negatively affected in December due to extreme weather conditions, and the trend continued in January with 2,000 store selling days affected.  However, Dollar Tree management believes that their strategies should work well in the long run, which is why they are confident of long-term growth.

But then, Dollar Tree's outlook for the ongoing quarter and the full fiscal year left a lot to be desired. The company expects earnings between $2.91 and $3.13 per share on revenue of $8.35 billion- $8.58 billion. These are well behind what analysts were expecting -- earnings of $3.25 per share on revenue of $8.6 billion.  This could be due to the fact that Dollar Tree's 2013 class of stores were not as productive as stores that were opened in 2012. The company saw a decline in store productivity due to the various reasons mentioned above, but it believes that things should get better as the year progresses.

Growth won't come easy
Going forward, Dollar Tree is focused on increasing store productivity through the development of new formats, and penetrating new markets and channels. It is planning a 7% increase in square footage this fiscal year, and is aggressively equipping its stores with coolers and freezers to drive sales of consumables higher. Consumables play an integral role in driving profits of the dollar stores, so it is quite natural for Dollar Tree to invest in this area. So, as Dollar Tree expands by 375 new stores this year, it should be able to capture more of the market.

However, this isn't going to be as easy as it sounds. Dollar Tree isn't the biggest discount store out there. With around 5,000 stores, it has fewer than half the stores of Wal-Mart and Dollar General. Size will matter in this industry, since the retailer with a higher number of stores will be able to serve a higher number of customers. So, while it is clear that Dollar Tree is expanding its store base and square footage, its rivals are also doing the same on a war footing.

Dollar General plans to open 700 stores in fiscal 2014, apart from relocating or remodeling 525 stores in an effort to boost productivity and profit. The company aims to grow its square footage by 6%-7% this fiscal year, which is almost on a par with Dollar Tree. Dollar Tree's smaller size isn't necessarily an advantage.

Moreover, Dollar General's move of selling tobacco is also helping sales. The company's revenue was up in the double digits in the previous quarter, increasing 10.5%, year over year. In comparison, Dollar Tree's sales in the previous quarter came in at $2.23 billion, a marginal drop from $2.25 billion posted in the year-ago period. In addition, Dollar Tree's same-store sales growth of 1.2% in the previous quarter lagged Dollar General's 4.4%. Dollar Tree's metrics aren't impressive, especially considering the fact that the stock is slightly expensive, as compared to Dollar General.

With the rollout of Wal-Mart's Neighborhood Markets and Wal-Mart Express this year, Dollar Tree's prospects could take another hit. The retail giant is planning to open 270-300 smaller-sized stores in 2014 as it looks to expand its footprint and tap the opportunity from which the dollar stores have benefited so far. In fact, same-store sales growth at Wal-Mart's small-box prototypes was 5% last year. The addition of Wal-Mart in the dollar store market will intensify price competition further, pressurizing margins of the dollar store chains.

Wait and watch
Dollar Tree has the best profit margin of all discount retailers at 7.61%. Both Dollar General and Family Dollar lag, with profit margins of 5.93% and 4.22%, respectively. So, Dollar Tree can afford to take a slight hit and continue its expansion efforts and aggressive pricing to ward off competition from rivals. But, Dollar Tree doesn't look like a sensible investment as of now since it is the most expensive stock in its peer group. So, it would be wise to wait and see how Dollar Tree copes up with the intensifying competition.

Harsh Chauhan 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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