Best Bets In Low-Cost Retail

Includes: COST, DG, FDO, TGT, WMT
by: Benjamin Goldman

With the economy turning toward recession and consumer confidence down, many investors have been buying into low-cost leaders in the consumer goods industry. Many discount stores, like Dollar General (NYSE:DG), have performed very well over the past few months compared to the rest of the market, while others, like Wal-Mart (NYSE:WMT), have outperformed the market, but have not had the same performance as their competitors. In this article, I use fundamental analysis and performance analysis to give Strong Buy, Buy, and Hold recommendations on 3 stocks in low-cost retail and give some brief insight on some other players in the industry.

Discount Stores

Strong Buy: Dollar General is my favorite stock of all of the low-cost leaders. Their strategy is to open stores in areas too sparsely populated for Wal-Mart to compete in, and then sell about 4,000 of the top 125,000 products that Wal-Mart offers. Dollar General currently operates in 35 states, and has plenty of room for expansion. In the last six months, Dollar General’s shares have increased by 19.67 percent, while the market has dropped 15.08 percent. The majority of Dollar General’s increased prices stem from its strong earnings report in late August. Dollar General’s stock is a rare opportunity to invest in a low-cost leader with plenty of space to grow.

Buy: Costco (NASDAQ:COST) is the largest warehouse club in the US and the ninth-largest retailer in the world. Its shares have increased by 10.6 percent in the past six months, which strongly outperformed the market. Costco’s earnings are expected to grow by 15.66 percent over the next year, which is pretty big for a retailer with such a large market presence. I believe that warehouse clubs will become more and more popular as consumer goods prices continue to increase and consumers look for new ways to save money. The one aspect of Costco stock that I fear is its short ratio of 3.5 percent, suggesting that investors believe that its shares are now overvalued.

Hold: Wal-Mart is the retail leader and the largest company in the world in terms of revenue, employees, and several other metrics. Wal-Mart shares have decreased by 0.44 percent over the past six months, which outperforms the market, but is stale in terms of performance relative to its competitors. Although Wal-Mart has room to grow in international markets and in its online sales, investors may continue to stay bearish on Wal-Mart shares because its market share is not being threatened by other large retailers. Wal-Mart’s main competitive advantage is its extremely efficient supply chain management, and it is definitely the main reason it rose to the top. However, many of Wal-Mart’s top competitors have developed equally effective supply chain management systems, and it looks like this capability is shifting from a competitive advantage to a cost of entry.

Conclusion: I believe that low-cost retailers on the whole are a good investment right now in a bear market and a possible recession. They should continue to perform well and meet or exceed their earnings expectations. There are a few other stocks in this space that deserve a look, like Target (NYSE:TGT) and Family Dollar (NYSE:FDO). I like how Target’s stores appeal to the upper-middle class and make innovative moves like their Missoni line. Family Dollar is very similar to Dollar General, but is smaller and is very behind in the information age, as many of its stores do not accept credit cards. Low-cost retail is a cut-throat industry characterized by high revenues and low margins. However, they may be profitable investments as most consumers turn to them to save money.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.