Rising Values for Dollar Stores


By Amy Tsao Dollar stores have long been considered the shopping haven for people at the lower end of the household income scale. But that has changed in recent years, and thanks to the deft strategies of the chains' managers, they remain one of retailing's few growth niches.

Little wonder then that the large, publicly traded operators in this arena have quietly become favorite places for Wall Street to shop, too. "It has been an unappreciated growth story, but they're gaining recognition because earnings are stable and fundamentals are improving," says Sara Henry, analyst at Sovereign Asset Management, a subsidiary of John Hancock Funds. (Henry doesn't own shares, but her firm owns Family Dollar [FDO

] stock.)

Indeed, even as the sector is near 52-week highs, the stocks may still be undervalued, analysts say. The average dollar-store share has risen 34% year-to-date, vs. a 13% rise for the Standard & Poor's 500-stock index, says Deutsche Bank Securities analyst Michael Baker, but he still sees continued potential. On June 17, he raised his targets on four companies' share prices, anticipating double-digit percentage gains. "We continue to see room for outperformance," he writes. (Deutsche Bank owns 1% or more of Family Dollar stock.)

IN THE BURBS. Dollar Tree (DLTR), Family Dollar, Dollar General (DG), and 99 Cents Stores (NDN)have refurbished their outlets to make them more appealing to higher-income customers. And for a variety of reasons -- including economic uncertainty and the low-price psychology instilled by Wal-Mart (WMT) -- dollar stores continue to gain in popularity among shoppers of all income levels. Some 36% of customers polled by market research firm Retail Forward frequent these stores monthly, up from 26% in 1997.

Macon Brock Jr., CEO of Dollar Tree, says even with a long track record of solid financial performance by his company and others, it has taken a long time to spiff up their image among consumers and investors. "America is just waking up to this new channel," he says (for an interview with Brock, see "Keeping the Bargain Hunters Happy").

Traditionally located in lower-income areas, these stores are increasingly being opened in more densely populated suburban neighborhoods. Sandy Skrovan, vice-president of market reseach firm Retail Forward says 69% of all U.S. household shoppers have been in a dollar store. "That's an enormous number," she says.

FILLING A VOID. Skrovan adds that the larger operators have improved the shopping experience. Stores are well-merchandised, cleaner, well-lit, and often in better locations, she says. (Skrovan doesn't own shares, and her company doesn't now perform consulting for any dollar stores.)

Even with some 16,400 dollar stores run by the top 10 companies, analysts say the rise of dollar stores may be just getting started. Filling the void between large discounters like Wal-Mart and the limited offerings and higher prices of convenience stores, each of the four major chains has its own twist on the concept and strengths in varying regions.

The U.S. could easily support 15,000 more dollar store outlets, says Skrovan. She figures each one needs about 3,000 to 4,000 households of just about any income to support it, while a retailer like Target (TGT) needs 25,000 households with an annual income level above $35,000 to support each store.

PICKING ONE. The major operators likely all have substantial store growth ahead, though valuations tend to reflect differing amounts of expansion ahead for individual companies, analysts say. For instance, 99 Cents, which has the smallest base, with 154 stores, trades at $34.50, or about 35 times 2003 earnings per share (EPS) estimates of 99 cents. More mature Dollar General and Family Dollar trade at $18 and $37, or 21 and 22 times fiscal 2004 EPS estimates, respectively. Family Dollar runs 4,839 stores, and Dollar General has 6,379.

Cary Nordan, an equity analyst at BB&T Asset Management, says he recently contemplated buying either Dollar Tree or 99 Cents, and opted for the former due to valuation. Dollar Tree trades at $33, or 21 times fiscal 2004 EPS of $1.53. With 2,318 stores, it says it can grow organically by 20% annually over the next few years and ultimately run 4,000 stores or more. "It's not that we didn't like 99 Cents," Nordan says. "It's just that Dollar Tree was a better value."

Charlotte (N.C.)-based Family Dollar has been a long-term holding for BB&T's mid-cap fund. "Family Dollar is a great operator and reports predictable results on the top line," says Nordan, noting it's perhaps the best way to get exposure to the group. Earlier this year, Wall Street had been concerned that Family Dollar would miss its stor-openings target, but it recently reassured investors that fiscal 2003 expansion plans were on track.

JEALOUS RIVALS. Sovereign's Henry says his firm owns Family Dollar stock in its fund that tracks top dividend performance. It's the only dollar-store stock that meets the fund's criteria of a 10-year history of rising dividends.

Supermarkets, drugstores, and convenience-store operators don't share Wall Street's enthusiasm for this niche market. That could have consequences for the dollar-store operators as these retailers think up their own competitive value-driven strategies in response to the increase in everything-for-a-buck and other low-price-point shopping. Save-A-Lot in 2002 bought a dollar-store chain, which it has since expanded. Wal-Mart is also testing a dollar concept within its combined supermarket and general merchandise Supercenter format.

Yet for now, investors and consumers both should see the appeal of dollar stores: Investors for better-than-average earnings growth and shoppers for the substantial bargains. Tsao covers financial markets for BusinessWeek Online in New York


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