Americans just love a bargain. That is what has kept Wal-Mart (WMT) in business for decades and is in the process of driving Best Buy (BBY) rapidly in the direction of bankruptcy, as the quest for better online deals has left the latter struggling with the equally unpalatable options of seeing sales plunge or watching its margins evaporate.
One group of retailers that has benefited from this trend has also qualified as market darlings until this year. Dollar stores like Dollar General Corp. (DG), Dollar Tree (DLTR) and Family Dollar (FDO) have thrived as the U.S. unemployment rate remains high and the economic outlook uncertain, but in recent weeks have seen their share prices drop sharply, despite the rally in the S&P 500, as seen in a stock chart.
The question now is whether that decline is merited, or whether the biggest bargain these dollar stores have to offer might be their own shares. Let’s dig into Dollar General, which recently was added to the S&P 500, to evaluate the merits of the bearish arguments put forth by the likes of Jim Cramer.
Certainly, the retailer itself is either blind to the risks or believes that the apparent signs of a slowdown are likely to be short lived. Dollar General plans to open another 635 retail outlets this year, which will bring the total north of 11,000. Is the market becoming saturated? Possibly not, but there is a risk that flat incomes and new taxes, combined with increased competition, will continue to take a toll on the company’s ability to tempt customers into all those stores, much less persuade them to spend on anything but the low-margin basics. Also, when chains expand rapidly -- hello Starbucks (SBUX) – they often end up grabbing less-than-great locations, and they strain management resources, which can lead to sloppiness and poor sales.
So far, at least, Dollar General’s margins show few signs of major problems, even if they are no longer climbing as they did two or three years ago. But it’s not what has happened – and thus can be seen on a chart – that has investors worried, but what might happen. For instance, the rate of same-store sales growth is already slowing. For the company’s third quarter, ended November 2, they climbed 4%, down from 6% in the year-earlier period. But even as Dollar General reported that operating profit hit a third quarter record and its earnings per share jumped 24% for the period, the company’s managers cautioned that margins might end up being squeezed as the company has to cut prices in order to keep sales growth intact. Adding cigarettes to the list of goods for sale won’t help margins either: the ticket price to consumers may be high, and they may serve as a way of coaxing shoppers into Dollar General rather than some other discounter or drug store, but margins are narrow.
To set against those worries about the future, Dollar General now offers a potentially alluring valuation.
The company’s PE ratio has fallen to only 16 times trailing earnings, and its PE/growth ratio is a remarkably low 0.47, haven fallen significantly over the last several months. In other words, the market is applying a hefty discount to the company’s growth.
It may boil down to just how fickle you believe cash-strapped consumers are, and how willing they will be to shift their loyalties based on a dime here or a nickel there in the price of a box of cereal or a gallon of milk. If the answer is “very”, then you’ll resist the temptation to get sucked into the stock of a company that could be caught up in a big price war. After all, Warren Buffett’s Berkshire Hathaway (BRK-B) has finally sold off a position in the company that he accumulated a year or two ago. On the flip side, some other savvy investors, like “Tiger cub” Steve Mandel of Lone Pine Capital and Ken Griffin of Citadel, are buying, and odds are they’re not doing so just because the company has been added to the S&P 500 index.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at firstname.lastname@example.org.
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