(By Kevin Donovan) Shares of stores with dollar in their name bucked the market sell-off Friday amid fresh concerns the economy is at best unrewarding and at worst tipping into recession. We think the belt-tightening plays make sense and have more to run.
The broad stock market was slapped down on news that nonfarm payrolls rose just 80,000 last month. The jobs gain failed to meet expectations and appeared to cement the notion that the economy thought to have been stirring last winter has slowed to near stall speed.
With the back-to-school shopping season, second only to Christmas for retailers, just around the corner, bargain stores are looking to siphon more dollars from uneasy consumers shunning higher-priced venues.
We looked at the stocks of three low-end retailing names – Dollar General (DG), Dollar Tree (DLTR) and Family Dollar (FDO). We like all three, but our favorite, based on valuation, is Family Dollar. It trades at a price to sales multiple of 0.88, compared with 1.18 and 1.84 for DG and DLTR, respectively.
On a forward price to earnings basis, FDO is cheapest at 16.09 versus respective multiples of 16.50 and 18.89 for DG and DLTR.
The stocks have been solid performers this year. FDO is again the laggard, up 19.14% year to date, versus share price gains of 31.96% and 29.98% for DG and DLTR, respectively.
Family Dollar was recently punished after reporting its fiscal third-quarter results late last month. Though earnings were largely in line with forecasts, the company's narrower guidance range displeased investors. What's more gross margins slipped 39 basis points.
Indeed, holding back Family Dollar are its lower margins. Its operating margin of 7.55% lags those of competitors' Dollar General and Dollar Tree, with margins of 10.18% and 11.87%, respectively. If FDO can control costs and boost margins, the stock could catch up its brethren.
CEO Howard R. Levine said the company took steps late in its third quarter to deliver increases sales per square foot. "As we complete most of these initiatives in the fourth quarter, we will have a fully competitive assortment and will be well-positioned to accelerate sales productivity further."
Family Dollar is the only one of its competitors to pay a dividend, which yields 1.23% at the recent share price of $69.30. So investors get paid while waiting for productivity to increase.
If you believe, as we do, that more economic weakness lies ahead, these companies should add customers and higher spend per customer as Americans set their sights on more affordable stuff they need.
In any event, that's what the market is banking on. Shares of Dollar General and Family Dollar are up again today. Dollar Tree has slipped on an analyst downgrade.
We expect the dollar store stocks to outperform the S&P 500 until the data, the Fed or Washington give investors something approaching confidence that animal spirits are reviving.