One of the most fundamental, yet
durable, competitive advantages lies in a firm's ability to undercut the
competition in terms of pricing and emerge as the low-cost provider.
Basic economic theory and simple common sense both tell us that consumers are
drawn to the lowest price available for a given product. When a company offers
thousands of everyday household products at lower prices than its competitors,
it should have little trouble attracting shoppers.
Not surprisingly, several companies have embraced this exact business model. In
the process, they have formed an industry unto itself -- deep-discount retail.
|
Major
Players in the Industry |
| Dollar General (DG) |
| Dollar Tree (DLTR) |
| Family Dollar (FDO) |
Given the similarities between their pricing and store formats, it may be tough
to distinguish one of these chains from another. However, the group as a whole
stands out conspicuously from more traditional (and more expensive) retail
sub-segments.
From humble beginnings in 1955, Dollar
General has expanded to the deep discounter industry's largest player in terms
of store locations. Family Dollar is the runner-up in the group, followed by
Dollar Tree.
A Brief Introduction
Most of us have visited a one of these stores at one point or another. In fact,
according to Morningstar, more than two-thirds of domestic households have
shopped at one of these deep-discounters over the past year.
For those who haven't, here is a brief summary of what types of products line
the shelves:
- Household cleaning chemicals,
detergents, etc.
- Candy, snacks, and soft drinks
- Toys and gifts
- Toothpaste, shampoo, and beauty aids
- Paint, hardware, automotive supplies
- Men's, women's & children's
shoes and apparel
For decades, these stores have
attracted customers on a fixed budget, or shoppers simply interested in trying
to save a few bucks.
To be sure, all of this merchandise can be found elsewhere, and the companies
listed face stiff competition from every angle. Not only must they compete with
each other, but they also must contend with larger traditional discounters like
Wal-Mart and Costco, as well as drugstores, grocery stores, and convenience
stores.
However, many deep-discount stores have been strategically located in smaller
rural markets or low-income urban areas where competition is less concentrated
(and rent is low). Furthermore, all of these different companies have co-existed
for many years.
As might be expected, margins in the
industry are on the thin side, as companies must sacrifice profits in order to
grab market share and keep customers loyal.
However, through the years the stores have learned to operate as lean and
efficiently as possible. They've also managed to adapt to changing economic
climates. Family Dollar, for example, has had the financial wherewithal to boost
its annual dividend payment for over two decades.
Reading the Labels
While shoppers might find little to separate these companies, investors must be
more discriminating.
With relatively low store overhead and
plenty of ground to cover, all three chains have expanded rapidly over the past
decade. As might be expected, this has translated into impressive top-line
growth rates.
However, as each company begins to operate a larger and larger store base, the
impact of this expansion will grow ever smaller. In this new environment,
same-store sales will become increasingly important. On that front, all three
firms have shown decent improvement, but Family Dollar is usually the leader in
this metric.
But when it comes to making sure that those sales filter down to the bottom
line, Dollar Tree has a clear advantage. Not only does the industry's smallest
player normally have the strongest gross and operating margins, it also converts
the largest percentage of its customers' dollars into free cash flow.
On the downside, Dollar Tree (as opposed to its two rivals) sticks almost
exclusively to items priced below $1. With less wiggle room to raise prices,
this policy might hamper the firm's ability to deliver higher same-store sales
and average ticket figures going forward.
One thing that all of the firms have going for them is innovation. Each has
added coolers to its stores that should help all three companies win over the
business of time-starved, one-stop customers in search of a few basic items.
Anyone who has tried to make a quick trip to Wal-Mart understands the
convenience of smaller stores and friendlier parking -- not to mention the added
fuel savings of consolidating several shopping trips into one. Finally, offering
staple consumable products like milk enables the stores to collect food stamps
-- an important feature for many low-income consumers.
Aside from the expanded grocery selection, the introduction of alternative forms
of payment (like debit cards) should also help squeeze a few extra bucks out of
many visitors. Even a modest uptick in average tickets would yield millions in
incremental sales generated over the course of a year.
While their obstacles are fierce, these
three companies have found a way to grow and profit in the face of adversity. As
each one expands in the future, investors may benefit from holding their shares.
|
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