Wal-Mart Stores Inc.'s (NYSE:WMT) massive e-commerce push is bad news for category killers like Staples Inc. (NASDAQ:SPLS) and dollar store operators like Dollar General (NYSE:DG) and the new Family Dollar/Dollar Tree Stores (NASDAQ:DLTR) combination.
Wal-Mart watchers know that online sales have been one of the few bright spots at the retail giant. Separate data about Wal-Mart's online retail sales for the U.S. are not available, but Wal-Mart's online sales globally grew by 27% in the first quarter of 2014 and 24% in the second quarter.
Over the past three years Wal-Mart has acquired 14 ecommerce companies for its @WalmartLabs social ecommerce experiment, including Luvocracy, Social Calendar, OneRiot Stylr, and Adchemy. The retailer has also experimented with a same day delivery option called Walmart to Go and in-store pickup of e-commerce orders.
Dollar Stores Don't Have the Cash to Compete with Walmart
All of this is a direct threat to category killers and dollar store operators because their cash flow is limited compared to Wal-Mart's. Wal-Mart has the cash to finance a massive online retail and social media push, while dollar store operators and category killers do not.
Wal-Mart reported a free cash flow of $3.78 billion on April 30, 2014. Dollar General reported a free cash flow of $167.3 million on the same day. Dollar Tree reported a free cash flow of $126.3 million on April 30, and Family Dollar reported $53.58 million, meaning a combined Dollar Tree/Family Dollar operation would have a free cash flow of around $179.88 million.
Staples, which does have a large online retail operation, reported a free cash flow of $311.85 million on April 30. Another category killer, Office Depot (NYSE:ODP), reported a free cash flow of -$115 million on June 30.
The free cash flow figures show the problem facing both category killers and dollar stores. Online retailers like Wal-Mart and Amazon.com Inc. (NASDAQ:AMZN) don't have to take a lot of their sales to hurt them. If just 5% to 10% of dollar store shoppers switch to online retailers, the fall in revenue for such chains could be catastrophic.
Office Suppliers' Dilemma Could Be Dollar Stores' Future
We've already seen a meltdown in the office supply retail market with Office Depot acquiring Office Max and closing 400 stores and Staples shutting down 225 stores. Office supplies are one of the markets with the most aggressive online retail competition. Wal-Mart's Sam's Club division now offers free shipping on many office supplies, while Staples offers free shipping on orders over $39.99.
Now I have to ask what happens when Wal-Mart starts using the same tactics in products that dollar stores specialize in, such as laundry detergent and cleaning supplies. Walmart.com already offers free shipping on all orders over $50 and prices comparable to dollar stores.
Online shopping is even more convenient than going to the dollar store (you don't even have to leave the house). More importantly, online retailers can offer a vast selection that dollar stores cannot match. There are more than 35 pages of listings for laundry detergent at Walmart.com alone. How is a dollar store with ten brands of laundry detergent supposed to compete with that?
Dollar stores' business model is to limit selection in order to keep costs and prices low. That business model works when competition is limited, i.e., the dollar store is the cheapest place in the neighborhood, so it is the most convenient option.
Now Walmart.com offers comparable prices; it's more convenient because it is right on your computer or your mobile device, and it has far greater selection. If you don't like Wal-Mart's prices, Amazon.com offers comparable prices and possibly a better selection.
The bottom line is that dollar stores are going to have a hard time surviving the online retail revolution. They lack the moat that Wal-Mart's cash flow gives it, and they don't have the resources to transform themselves into online retailers.
My prediction is that the catastrophe we've seen in the office supply category will be repeated in the dollar store sector. Expect to see large numbers of store closings, falling share prices, and mergers as companies desperately scramble to survive.
This drama has already begun with the Family Dollar/Dollar Tree merger and Family Dollar's closing of 370 stores. Those moves came after Family Dollar's revenues fell by 6%. Dollar Tree bulls had better pay attention to Office Depot, which had a share price of $5.08 on August 14, 2014.
The online retail revolution might be Wal-Mart's salvation, but it could be the end of the line for a lot of lesser brick and mortar chains. One has to wonder which retail sector will be hurt next.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author conducts some retail sales through Amazon.com.