Retail is detail. Discount stores face a challenging marketplace where they have large fixed costs and slim margins. The industry has slowly grown more concentrated with the emergence of superstores like Wal-Mart (WMT) and a constant push towards ever-greater scale to enhance purchasing power.
The recent Great Recession has pushed more consumers towards these stores for many of their needs. Shoppers have scaled back from department stores and specialty stores to discounters. Even within the industry, other shoppers have scaled down further. Discount stores are now furthermore pressured from below by alternative options ranging from eBay (EBAY) to thrift stores and even garage sales.
Evaluating retail stocks requires significant assessment of their operational capabilities. Metrics such as inventory turnover and cash conversion cycles are key. Table 1 shows the leading publicly-traded discount stores with some basic data. The discount store industry is dominated by a few larger names to a greater extent than the grocery store industry.
Table 1: Publicly Traded Discount Stores
| Ticker | Name | Price ($/share) | Enterprise Value ($ Billions) | Trailing P/E | Forward P/E | Revenues (ttm) ($ Billions) | Fiscal Year End |
| WMT | Wal-Mart Stores Inc. | $55.69 | $ 245.2 | 13.8 | 12.6 | $419.2 | January |
| COST | Costco Wholesale Corp. | $75.04 | $ 27.8 | 24.6 | 18.6 | $79.9 | August |
| TGT | Target Corp. | $54.39 | $ 53.5 | 14.3 | 12.2 | $66.9 | January |
| DG | Dollar General Corporation | $27.24 | $ 12.5 | 19.3 | 12.9 | $12.7 | January |
| BJ | BJ's Wholesale Club Inc. | $49.37 | $ 2.3 | 18.9 | 15.2 | $10.8 | January |
| FDO | Family Dollar Stores, Inc. | $44.16 | $ 5.3 | 16.1 | 11.5 | $ 8.0 | August |
| DLTR | Dollar Tree | $50.50 | $ 6.1 | 17.5 | 13.4 | $ 5.7 | January |
| BIG | Big Lots, Inc. | $41.57 | $ 2.5 | 15.0 | 10.4 | $ 4.9 | January |
| FRED | Fred's Inc. | $13.07 | $ 0.5 | 19.2 | 14.6 | $ 1.8 | January |
| PSMT | PriceSmart Inc. | $37.68 | $ 1.1 | 20.9 | 15.6 | $ 1.5 | August |
| NDN | 99 Cents Only | $16.63 | $ 0.9 | 15.7 | 12.7 | $ 1.4 | March |
| TUES | Tuesday Morning Corporation | $4.92 | $ 0.2 | 17.9 | 9.9 | $ 0.8 | June |
Data sourced from Yahoo!Finance on February 13, 2011.
Analysis
The following analysis looks at four metrics:
- Inventory Turnover.
- Cash Conversion Cycle.
- Asset Turnover.
- Profitability Margins (based on the most recent trailing 12 months to assess whether the previous measures in operating performance resulted in higher profitability).
Inventory Turnover
For a retailer, inventory turnover is one of the most basic measures of operating efficiency. Basically, how rapidly can the company sell a set of goods and replace it? Stores with larger assortments of goods may take longer. Furthermore, stores with grocery operations are often forced to have higher turnovers simply due to the perishable nature of their goods.
| Ticker | Most Recent Full Year | Year Prior |
| COST | 12.3x | 11.9x |
| BJ | 10.1x | 10.4x |
| PSMT | 9.4x | 9.1x |
| WMT | 9.0x | 8.7x |
| TGT | 6.6x | 6.8x |
| DG | 5.5x | 5.2x |
| FDO | 5.0x | 4.8x |
| DLTR | 5.0x | 4.6x |
| NDN | 4.9x | 5.3x |
| FRED | 4.3x | 4.1x |
| BIG | 3.8x | 3.8x |
| TUES | 2.2x | 2.2x |
Here the large-scale operations dominate, taking four of the top five spaces. The notable exception is PriceSmart, which is ranked just 10th in revenue. It should be noted that PriceSmart has had a more recent fiscal year-end which may skew the results, making its most recent year longer post-recession; however, its prior year performance was equally strong, and these metrics show little change from one year to the next.
Cash Conversion Cycle
Cash conversion cycle is a measure of how quickly a company pays its suppliers, receives money from customers, and the amount of inventory it carries. Negative numbers represent float on which the company can earn interest. High numbers represent either low inventory turnover, demanding terms from suppliers, or an inability to get cash from customers.
| Ticker | Most Recent Full Year | Year Prior |
| WMT | -14.7 | -9.9 |
| COST | -4.7 | -4.8 |
| PSMT | -3.8 | -2.4 |
| BJ | 2.7 | 8.4 |
| FDO | 5.9 | 8.0 |
| DG | 15.4 | 17.8 |
| TGT | 22.0 | 34.1 |
| NDN | 26.5 | 39.6 |
| BIG | 35.0 | 45.7 |
| DLTR | 46.3 | 50.8 |
| FRED | 55.3 | 65.8 |
| TUES | 102.5 | 106.6 |
This metric shows few surprises. WMT is the leader and the larger companies by revenue tend to perform better, with the notable exception of PSMT.
Asset Turnover
| Ticker | Most Recent Full Year | Year Prior |
| BJ | 4.87x | 4.93x |
| COST | 3.40x | 3.35x |
| FRED | 3.20x | 3.28x |
| BIG | 3.05x | 3.23x |
| FDO | 2.69x | 2.67x |
| PSMT | 2.63x | 2.67x |
| TUES | 2.47x | 2.43x |
| WMT | 2.44x | 2.47x |
| DLTR | 2.42x | 2.43x |
| NDN | 1.92x | 1.99x |
| TGT | 1.47x | 1.47x |
| DG | 1.33x | 1.18x |
This metric is reasonably consistent with expectations. The large wholesale clubs with no frills stores have the highest asset turnover, followed by Big Lots, which is a smaller-scale operation but also lacks frills inside its stores. The bottom of the list includes Target, which has been trying to move more upscale with remodeled stores.
Profitability Margins
| Ticker | Gross Margin | Operating Margin | Profit Margin |
| DLTR | 35.3 | 10.3 | 6.5 |
| DG | 32.0 | 9.0 | 3.9 |
| NDN | 41.3 | 7.9 | 5.2 |
| TGT | 29.8 | 7.6 | 4.2 |
| FDO | 35.7 | 7.3 | 4.5 |
| BIG | 40.8 | 7.2 | 4.4 |
| WMT | 25.2 | 6.1 | 3.6 |
| PSMT | 16.6 | 5.6 | 3.7 |
| COST | 12.8 | 2.7 | 1.7 |
| TUES | 38.2 | 2.6 | 1.4 |
| FRED | 28.4 | 2.3 | 1.5 |
| BJ | 12.3 | 2.2 | 1.3 |
| Ticker | Most Recent Full Year | Year Prior | Two Years Prior |
| DLTR | 6.1% | 4.9% | 4.7% |
| FDO | 4.6% | 3.9% | 3.3% |
| NDN | 4.5% | 0.7% | 0.2% |
| BIG | 4.2% | 3.3% | 3.4% |
| TGT | 3.8% | 3.4% | 4.5% |
| PSMT | 3.5% | 3.4% | 3.4% |
| WMT | 3.5% | 3.3% | 3.4% |
| DG | 2.9% | 1.0% | 1.0% |
| COST | 1.7% | 1.5% | 1.8% |
| FRED | 1.3% | 0.9% | 0.6% |
| TUES | 1.3% | 0.0% | 1.6% |
| BJ | 1.3% | 1.3% | 1.4% |
The profitability data shows some interesting trends and suggests that not all discounters compete in the same space.
Conclusion
I previously wrote an article on managing cash at grocery stores which have to operate with very slim margins. It is quite apparent that the same principles apply to discount stores, which offer significant overlap, with Wal-Mart and Target being larger retailers of food.
PriceSmart appears to be a potential long option, given its strong operational metrics and reasonable margins. One interesting aspect is that, despite one of the lowest gross margins, it provides an average net income. However, its operational requirements are probably a necessity, since despite a gross margin 3-4 percentage points higher than Costco and BJs, PriceSmart has a profit margin only 2 percentage points higher. The key question is how much better will PriceSmart look once it scales up in size.
Fred's and Tuesday Morning appear to be poorly positioned; despite high gross margins, they provided two of the lowest three net margins. Both companies lack scale and have limited recent growth. While they have decent asset turnover, their inventory turnover and cash management are ranked near the bottom.
The final interesting company is Dollar Tree, which shows high margins but average operational metrics. Additional analysis should always be completed prior to making an invesment decision.
