The Recession Proof Play: Dollar Stores

  • Dollar stores are taking over rural America, with strong annual growth numbers and strong sales
  • The growing wealth gap enables this takeover, and encourages Dollar Stores to grow at a rate of over 1,000 stores per year
  • If we enter into a Recession, Dollar Stores could gain even more traction

The Dollarization of America

Grocery stores have evolved over time, from first delivering non-perishables such as spices and teas to becoming digitally integrated supercenters that offer everything from tires to papayas. The Piggly Wiggly was the first self-service grocery store, established in  1916. Since then, the $820 billion Consumer Packaged Goods industry has seen rapid growth, encompassing everything from home delivery services to online grocery shopping.

However, there is a polarization among the evolution of grocery stores, a process that has been occurring since the early 2000’s. There is a fork in the road in how the industry will continue to progress, as naturally, some shops will appeal to upper income consumers, and other shops will target lower income consumers.

The Dollar Stores: The Tree and the General

Dollar stores are taking over America, and for several reasons. The stores operate on thin margins, which enables them to provide discounted goods.They target rural communities who often do not have a grocery store in their town, which gives the dollar stores a monopoly on those communities. In fact, when Dollar Stores enter an area, the sales at a grocery store in the same area decline by 30% on average.

Nielsen-Retail-Open-Store-Changes-2007-2017-Apr2018

Source: Marketing Charts

And they are growing at a rapid pace, increasing by more than 11,000 stores over the past 10 years, with plans to grow even more. Their growth is 5 times that of supermarkets and supercenters. This is coupled with the fact that the competition in the dollar store market is small, composed of only two key groups.

The Land of Two: No Competition Where Everything is One Dollar

There are two key players in the dollar store industry – Dollar Tree (DLTR) and Dollar General (DG). Family Dollar used to be a player, but was acquired by Dollar Tree in 2014  for $9.2 billion. Dollar General operates 15,000 stores, a similar number to Dollar Tree, even after latter’s divestment of 300 stores to appeal to the FTC after the Family Dollar acquisition.

There is a key difference between Dollar Tree and Dollar General. Dollar General operates more as a discount retailer, whereas Dollar Tree literally offers products that are only $1. Dollar Trees are often larger, and focus on seasonal products and less focus on grocery items, whereas Dollar Generals tend to be smaller with more focus on the necessities.

Dollar General is one of the most profitable stores in the rural US. Sometimes, it’s the only store in the town that offers grocery products. In fact, there are more Dollar Generals than there are McDonalds, which highlights the sheer ubiquity of the company. The Dollar Stores are in places where Walmart won’t even go, and that gives them strength, and a grip-hold on communities.

dollar-store-state-map-768x576

Source: ILSR

With estimates that 75% of the population lives within 5 miles of one of their stores, Dollar Stores have the reach necessary to be successful. Walmart, the dollar store’s biggest competitor in terms of price point, has locations that only reach 37% of the population within that same 5 mile radius.

Inflating the Dollar: Reaching Every Small Town

Dollar General alone is expected to open 900 stores this year, at a clip of 3 stores per day. They are on a path to open the most retail stores out of all retailers in 2018, more than 2.8 times that of Dollar Tree. As an added bonus, Dollar General doesn’t own the stores that they operate, and those stores are small, averaging about 7,000 square feet. Both of those things assist in keeping costs low.

2018-store-openings-300x169

Source: CB Insights

In fact, since 2008, 76% of all net new store openings for the retail industry as a whole have been Dollar General. While everyone else is shutting their doors, Dollar General continues to open stores at a breakneck speed.

DG vs net new store openings_0

Source: Zero Hedge

General George Washington: The Competitive Advantage of Dollar Stores

The dollar stores have several competitive advantages, including operating on thin margins and small stores. But they also offer a smaller number of products, usually around 10,000 to 12,000 unique products, which is 6 times less than that of Walmart’s 60,000 product offering line. They have a smaller workforce. Most of the stores don’t carry fresh food or other perishable goods.

With a price point that ranges between 20% – 40% less than traditional grocery stores, they are making strides at razor thin margins. With an expected market growth of 8% for the coming year, Dollar General alone has a combination of attributes that will leave any competitor in the dust, including its rival, Dollar Tree.

People seem to view both dollar stores as a sort of  “experience” that combines the usual grocery trip with that of shopping at a novelty shop. When people go to the Dollar Tree or the Dollar General, they “just go”. That type of mindset can encourage consumers to purchase goods that they didn’t necessarily go to the store for, and can improve the dollar stores bottom line.

dollar-store-versus-600

Source: Hartman Group

However, the dollar stores biggest profit making tactic is consumer psychology. They trick people into paying less, but paying more per-ounce because the quantities offered are smaller. People think that they are paying less for the product that they purchasing, but really they are paying more down the line. Paying $1 for 12 oz now at the dollar store, sounds a lot better than paying $1.5 for 24 oz at the supermarket, but that 0.50 cent difference coupled with the smaller quantity adds up over time. A simplistic example, but even after the second purchase, the dollar store ends up costing more for the consumer later on.

Regardless, the growth of both the Dollar Tree and the Dollar General reflects the growing wealth gap in America. Their target market makes less than $40,000 a year. As the Dollar General CEO says, “The economy is continuing to create more of our core customer“.

The Income Gap: The Importance of Just One Dollar 

The middle class has been shrinking over time, with more people entering into both the upper income and lower income classes. Dollar stores are able to capitalize on that movement, offering low-priced products that appeal specifically to low income consumers.

wealth gap

Source: Financial Times

Their sales have surged, whereas the sales of  groups like Whole Foods have flatlined. Whole Foods is on the opposite end of the spectrum, and is also appealing to the polarization of the wealth gap, but they target the top 10% in the income distribution. Acquired by Amazon over a year ago, the company operates 448 stores, growing 62.9% from 2008 numbers. As stated by Dennis Berman, “Amazon did not just buy Whole Foods grocery stores. It bought upper-income, prime-location distribution nodes for everything it does”

The Dollar stores have grown at a clip of 73.8% over the same time period. Amazon might have bought Whole Foods for its distribution opportunities, but they probably would have been better off buying a couple of Dollar Generals instead.

dollar tree1

Source: ISLR

The Dollar Store Experience: Turning One Dollar into Many

All of this adds up into a pretty strong profile for the Dollar stores. They are insulated from the necessity of innovation, because their core customer does not require a showroom experience or an online platform. Dollar stores operate lean, and that allows them to avoid the ongoing supermarket transformation, and protect them from some of the issues plaguing the industry.

They are exploding into rural communities, taking advantage of the divergence in wealth that we are experiencing. As the potential for a recession rises, the dollar store format will continue to gain traction as people seek out deals and perceived money-saving tactics.

Dollar-Store-Stock-Comparison-Chart-768x432

Source: CB Insights

They have an incredible operating style, which is hard to replicate. They have low labor costs, small and simplistic stores, a limited number of products, and an efficient supply chain. Their sales and growth numbers are unparalleled.

Fro Q3 2018, net sales increased 8.7% for Dollar General, with same-store sales up 2.8%. Cash flows increased 32.5%. Net income grew 34%. Dollar Tree saw a 4.2% increase in net sales, with same-store sales up 2.3%. Net income grew 14%. Both companies delivered strong results during a time where retail as an industry was quite shaky.

However, they do have some challenges, including the overall drop in food prices across America. Also, Walmart is a behemoth that can capitalize on various opportunities and isn’t afraid to do so. Amazon just entered the space, and surely has some sort of plan to move forward. The dollar stores are also growing at what seems to be an unsustainable pace, but if a recession occurs, they will be perfectly prepared.

Overall, the dollar stores should continue to take share in grocery, especially if pressure on the economy increases. It’s almost niche in its offerings, and has a monopoly on several rural communities. As the world of retail evolves, Dollar General especially has a business plan that appears to be bulletproof, and will continue to be profitable.

dt

Source: Yahoo Finance

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.

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