Think no one can compete with
? Think again.
Consider the rinky-dink dollar store. By marrying two seemingly incompatible ideas -- convenience and value -- the age-old concept has struck a chord with consumers and investors alike. Now, with earnings and sales growing as never before, the overlooked dollar store is suddenly retail's hottest concept.
Including names such as
99 Cents Only Stores
, the sector boasts some of the strongest fundamentals in retail.
"Within the discount sector, the dollar stores occupy a convenience niche," says Michael Baker, who follows dollar stores for Deutsche Bank Securities. "As Wal-Mart rolls out bigger and bigger stores, we think there is an opportunity for smaller-box stores."
Good as Gold
The industry has successfully grown sales while going head-to-head with discount giants Wal-Mart,
. The dollar-store group boasts the second-highest sales growth rate in all of retail, just behind
, the discounter-department store hybrid whose growth and stock price seem to have no limit.
Overall, the industry is slated to grow sales at an average annual clip of 17%, just below the 19% projected growth rate for Kohl's, according to Merrill Lynch, which recently published a voluminous 111-page treatise on why investors should dive into dollar-store stocks. Earnings are projected to grow at a robust annual rate north of 20% for most of these outfits.
Projected Annual Sales Growth
Source: Merrill Lynch estimates
"We believe that over time, as the
market capitalizations of dollar stores rise, multiples in the sector will expand further," wrote Merrill analyst Dan Barry in a recent report. The expanding multiples will give investors "the ideal combination of above-average earnings growth and rising valuations." (Merrill has a strong buy rating for the sector and has had banking relationships with the companies.)
Of course, this isn't an ointment utterly without flies. Many analysts recommend that investors steer clear of Dollar General, for instance, because of its recent earnings
restatements and an ongoing
Securities and Exchange Commission
accounting probe. Other worries in the sector include the stocks' premium valuations and the threat of competition.
Seizing on Size
That said, these little companies have done what few people thought was possible. What about the mantra that no one can compete with Wal-Mart on price? Toss it out the window. Consider this: About 65% of Dollar General and Family Dollar stores are within a five-mile radius of a Wal-Mart -- yet both have consistently reported solid gains in comparable-store sales, which measure activity in shops open at least a year, according to Merrill.
In the latest quarter, Family Dollar reported an 8% rise in same-store sales, while Dollar General saw comps add 6.7%. Other fundamentals are solid as well: 99 Cents Only Stores shows the highest return on capital among all hard-goods retailers, according to Deutsche Bank.
The tech bust is helping these stocks, too. Small- and mid-cap stocks lagged during the late 1990s' bull market as cash flooded into technology stocks. But with the crash of the tech sector, investors have returned to smaller-cap companies in unsexy areas.
Bucking the Trend
As a result, Dollar Tree has risen 24% this year, 99 Cents Only has jumped 12% and Family Dollar has added 20%. Going by
price-to-earnings figures, the group now trades at a 24% premium to the
-- yet the sectorwide premium is lower than it was before the late-1990s bubble, Merrill notes. In 1997-98, the stocks commanded a 30% to 40% premium to the market.
"Valuations have not recovered back to their former highs," wrote Merrill's Barry, "yet we feel the fundamentals justify a return to such levels, barring another tech bubble."
These days, a return of the tech bubble seems a far-out proposition indeed.