Seeking Alpha
Long only, deep value, contrarian, momentum
Profile| Send Message|
( followers)  

Summary

  • Dollar Tree’s Family Dollar acquisition shows the desperate situation dollar store operators are in.
  • Dollar store operators like Dollar General may have too narrow a focus to survive in a retail landscape dominated by Amazon.com.
  • Online retailers are a growing threat to dollar store operators because they can match their prices and provide greater convenience to shoppers.
  • The combined market caps of Family Dollar and Dollar Tree indicate the new merged entity would still lack the resources to compete with Amazon.com, Wal-Mart, Costco, Walgreen or CVS Caremark.
  • A comparison of revenues indicates that Family Dollar–Dollar Tree and Dollar General have an outdated business model that might not survive in today’s brutal retail environment.

The acquisition of Family Dollar Stores (NYSE:FDO) by Dollar Tree Stores (NASDAQ:DLTR) demonstrates just how rough today's retail environment is for mid-sized discounters. The merger looks like a desperate ploy for survival rather than an attempt to dominate the industry.

Like other narrowly focused retailers or category killers, such as Staples Inc. (NASDAQ:SPLS), Office Depot (NASDAQ:ODP), and Radio Shack (NYSE:RSH), these low-end discounters are having a hard time competing and surviving in the age of "the everything store." The "everything stores" are gigantic retailers such as Amazon.com (NASDAQ:AMZN), Costco Wholesale (NASDAQ:COST), Alibaba, and Wal-Mart Stores Inc. (NYSE:WMT) that offer vast selections at low prices.

Stores like Family Dollar and Dollar Tree used to merely have to deal with neighborhood competitors, including grocers like Kroger (NYSE:KR), drugstore operators like Walgreen(NYSE:WAG), and big box operators like Wal-Mart. They still face those aggressive competitors and online retailers like Amazon.com and potentially Google's (NASDAQ:GOOG) Shopping Express.

Online Retailers Target Middle Class

Okay, Amazon.com and Google Shopping Express may not take away Family Dollar's core customers - lower-income people - but by making it possible to order laundry detergent and toilet paper from home, they do attract some middle class customers that might have shopped at the dollar store.

This is especially tough on dollar store operators dealing with food stamp and benefits cuts. The dollar stores need every customer they can get, and online retailers offer a more convenient alternative that frees middle class shoppers of the need to go to the dollar store.

To make matters worse, online retailers' prices on some of the goods dollar stores sell are getting competitive. On July 29 Walmart.com was selling 92 ounces of Tide laundry detergent for $9.87, while my local Family Dollar was selling 69-75 ounces of Tide for $7.50. The middle class has fewer and fewer incentives to shop at the dollar stores at a time when the dollar stores need their business.

Simply Not Big Enough to Survive

Yet the loss of the middle class is not the real threat to dollar stores' survival; lack of size and buying power is. Even the combined Dollar Tree-Family Dollar might not be big enough to survive today's increasingly intense retail wars. It and its main competitor, Dollar General (NYSE:DG), may simply lack the resources to build moats capable of protecting them from technologically savvy competitors.

The market cap numbers tell the story far better than I could. Even after its merger, Family Dollar-Dollar Tree - or whatever it wants to call itself - will still be a David facing an army of Goliaths. To make the duel even more one sided, the dollar-store David is carrying a sling shot, while the Goliaths are armed with assault rifles.

As of July 29, 2014, Dollar Tree had a market cap of $11.27 billion and Family Dollar had a market cap of $8.622 billion. That means a combined Tree and Family would have a market cap of around $19.892 billion; that's larger than the main dollar store rival, Dollar General, which had a market cap of $16.58 billion.

The problem for dollar store operators is that neither of these figures comes close to their competitors in the big box, grocery, club store, drugstore, or online retail fields. Here are some market cap figures for retailers that compete directly or indirectly with dollar stores:

  • Wal-Mart Stores Inc: $244.06 billion
  • Amazon.com Inc.: $147.99 billion
  • Costco Wholesale: $52.12 billion
  • Walgreen: $67.12 billion
  • CVS Caremark (NYSE:CVS): $91.64 billion
  • Kroger: $24.58 billion
  • Target (NYSE:TGT): $38.72 billion

Some people will say this isn't fair; these companies operate in many markets, while dollar stores operate in one limited field. Well, that's the point; the competitors have many different markets and sources of revenue to draw upon. The dollar stores operate in just one very limited field that offers limited revenues.

Tiny Resources Compared to Potential Foes

Here's some TTM revenue food for thought:

  • Wal-Mart Stores Inc.: $477.03 billion
  • Amazon.com: $81.76 billion
  • Costco Wholesale: $109.60 billion
  • Walgreen: $75.28 billion
  • CVS Caremark: $128.69 billion
  • Kroger: $101.29 billion
  • Target: $72.94 billion

These revenues, which are partially rooted in the huge variety of goods they sell, give these retail giants wide moats. They can afford to take losses in the retail wars, sometimes huge losses, while Family Dollar-Dollar Tree and its ilk cannot.

Family Dollar Stores reported a TTM revenue of $10.38 billion on May 31, 2014. A month earlier, on April 30, Dollar Tree reported a TTM revenue of $7.97 billion. That would give the combined dollar store operator a TTM revenue of around $18.35 not counting the cost of the merger. Dollar General reported a TTM revenue figure of $17.79 billion on April 30.

These figures show that even after the merger, the dollar store operators simply lack the resources to compete and survive in today's increasingly complex and competitive retail environment. They simply don't have the moat necessary to defend themselves against attacks from Wal-Mart or Amazon.com. Those attacks have already begun, and they're going to grow in scope and intensity.

My prediction: both Dollar General and the new Dollar Tree-Family Dollar combination will have a tough time surviving. They simply lack the size, cash, and clout to survive let alone prosper in retail-killing fields. Perhaps the dollar stores' real problem is an outdated business model, a problem that no merger can fix.

Source: Family Dollar/Dollar Tree Combination Still Too Small To Survive

Additional disclosure: The author conducts some online retail sales through Amazon.com.