The dollar store industry could be the most exciting to watch in the next 12-18 months.
We think Wal-Mart may take a stab at one of a number of industry constituents.
Dollar General is operating at the highest level among peers.
The dollar-store industry provides consumable basic needs to customers primarily in the low and middle-income brackets. More than one-third of the industry's customers live in households that earn less than $20,000 per year, making the group's results counter-cyclical -- as more households generate lower income due to poor economic conditions. Therefore, store growth and same-store-sales increase during these bumpy times. Still, competition is fierce among constituents. But given the niche low-price strategy of participants and their counter-cyclical nature, we tend to like the group.
Dollar General Still Operating Best-in-Class
Dollar General (NYSE:DG) has been operating at a level higher than that of its dollar-store peers, but its outlook for fiscal year 2014, released in its fourth quarter report March 13, came up a bit short. The company's fourth-quarter sales advanced 6.8%, while fourth-quarter same-store-sales edged up a modest 1.3%. These numbers showed a deceleration from the pace of its third-quarter performance, where total sales jumped 10.5% and same-store sales advanced 4.4%.
The fourth-quarter top-line expansion was also less than that of the full year, where sales jumped 9.2% on a consolidated basis and 3.3% on a same-store basis (marking the twenty-fourth consecutive year of same-store-sales expansion). Free cash flow totaled $674.62 million, up more than 20% from last year's mark of $559.76 million and representing about 3.9% of annual sales. We liked the growth rate in free cash flow during the year. On an adjusted basis, earnings per share leapt 10% to $3.20 per share for fiscal 2013. Both are solid numbers.
Though the quarterly performance was affected by severe winter weather and an aggressive retail market environment (the company said as much in the release), Dollar General was still very "cautious on the current operating environment" and "the many challenges that its core customer is facing in 2014". The firm is poised to show another year of same-store sales expansion in 2014, while adding a large number of new stores, but its bottom-line outlook came in a bit shy of what I was looking for.
Still, despite the lower than expected profit outlook, more conservative capital spending should continue to drive a nice pace of free cash flow expansion at the company. Dollar General is one of the best operators in its industry, particularly on the basis of its stand-out third-quarter results (ended November 1), which were not affected by weather.
Though open is the possibility that Dollar General will exceed its fiscal 2014 bottom-line forecasts on the prospect of improved cost controls, the competitive environment in the dollar-store space is heating up. Big Lots (NYSE:BIG) is adding freezers and coolers to hundreds of stores to help capture more of the food stamp business. Wal-Mart (NYSE:WMT) plans to open up 300 Neighborhood Markets and Walmart Express stores (these stores are a fraction of the size of its Supercenters), creating additional competition and potentially squeezing out longer-term growth plans for the discount retailer group.
The likelihood of consolidation across the dollar-store space is becoming increasingly likely, particularly as Wal-Mart stretches for growth. In our view, Wal-Mart could take a stab at either Dollar General or Family Dollar (NYSE:FDO) in coming periods, or even the latter two might combine to achieve greater scale, density, and purchasing synergies to compete against Wal-Mart and Target (TGT). We think the key beneficiaries of such activities will be the consumer, as we fully expect some, if not all, of the cost savings and synergies under a large consolidation scenario involving Wal-Mart or among dollar store peers to flow to them.
If the consolidation dominos begin among any one of the industry constituents, we would fully expect the remaining participants to actively begin looking for a merger partner. The fourth-quarter performance of Dollar Tree, for example, wasn't fantastic, and we don't think it would sit out if Family Dollar or Dollar General become active on the M&A front. The push for a higher minimum wage may be yet another catalyst to force the group into some M&A activity (to offset the higher costs), but the magnitude of any proposed minimum wage hike is uncertain at this juncture. Given the recent credit card debacle at Target, however, we don't think it will be participating in any tie-ups soon.
In any case, we think the dollar-store space will be one of the most exciting to watch over the next 12 to 18 months. Stay tuned.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.