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Making Change: Dollar General Battles Dollar Tree


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Like shoppers elbowing for deals at a clearance rack, America's three major dollar stores are focusing their sights on one another. And the situation is fiercer than a Black Friday sale at midnight.

The outright winner remains to be seen, but dollar stores continue to rake in the dollars, regardless of the slothy economic recovery.

Dollar General ( DG ), which has been unsuccessfully angling to acquireFamily Dollar ( FDO ), announced on Sept. 10 that it was commencing an all-cash tender offer of $80 a share for the second-largest dollar store chain.

The hostile bid, valued at about $9.1 billion, came weeks after Family Dollar had announced a merger with the industry's number three player,Dollar Tree ( DLTR ).

Family Dollar has snubbed the heftier Dollar General bid, insisting on sticking to Dollar Tree's lower July bid of $74.50 a share in cash and stock.

Family Dollar says that it has rejected Dollar General's offers due to antitrust regulatory concerns.

The chains are massive. Dollar General has almost 11,500 stores across 40 states. Family Dollar has well over 8,000 stores. A merger would create a discount retailer with almost 20,000 locations and sales of more than $28 billion, according to Dollar General.Wal-Mart ( WMT ), by comparison, has just over 10,000 stores worldwide.

In an effort to appease FTC regulators, General has said that it would divest up to 1,500 stores, if needed. Some analysts say that the number would have to be higher.

"(Family Dollar and Dollar General) would have 20,000 stores, 6,000 of which are within 3 miles of each other," Wedbush analyst Joan Storms told IBD. "That almost dictates that you'd have to close about 5,000 stores."

Dollar General sweetened its bid, agreeing to pay Family Dollar a $500 million reverse break-up fee if the deal were blocked by antitrust red tape. General's CEO, Rick Dreiling, said in a release that the company is starting the antitrust review process and will present directly to the FTC.

"As we previously have stated, we are confident in the results of our antitrust analysis, and we look forward to a constructive dialogue with the FTC," Dreiling said in a Sept. 10 statement.

Dollar Tree hasn't made a counter-offer. If it eventually succeeds, a Dollar Tree-Family Dollar combination would leapfrog Dollar General, creating the country's No. 1 discount retailer, with more than 13,000 stores.

1.Business

Dollar General and Family Dollar both offer a range of items under $10. Dollar Tree packs its shelves with goods priced at $1 apiece. All three stores target lower- to middle-income consumers. But Dollar Tree's customer base tends to be more varied, analysts say, owing to where it locates its stores, what it offers and, oddly enough, its prices.

Dollar Tree's price range provides shopping opportunities "at various income points," said Wells Fargo analyst Matt Nemer.

Nemer points to children's birthday parties and back-to-school season as necessities bringing in consumers at various income levels. Dollar Tree also lures shoppers simply out on treasure hunts.

"Dollar Tree is more of a variety store -- everything's $1. It's a really fun store," said Wedbush's Storms, noting that Tree customers have a little more income due to the chain's suburban locations. Dollar General has a large presence in rural areas. Family Dollar is in many rural and urban markets.

Inventory productivity is vital to discount chains, she added: "You need to make sure you have the right things in the right aisle at the right price every day."

Dollar Tree's same-store sales for the second quarter, which ended in August, rose 4.5%. Dollar General's Q2 comps rose 2.1%. Family Dollar last reported in July, with comps down 1.8% for the quarter ended in June.

While Dollar General and Family Dollar have similar price schemes and overlapping geographies, "Dollar General has much higher sales productivity, and generates more sales per foot," said Nemer.

That owes, he said, to adept management on the consumables side of the business, like foods and paper goods, which tend to draw repeat customers.

General went private in 2007 and then public again in 2009. It has a more effective management team than Family, according to Nemer. He attributes its improvement in recent years not to any major isolated factors but to many small ones -- everything from raised shelf height to better signage to a good/better/best merchandise assortment.

Family, on the other hand, has been slow in catching up. Unlike its peers, the company has seen year-over-year earnings losses for the past three quarters. Consolidation isn't necessary, said Nemer, but Family's hand may be forced.

"I think the issue is that Family Dollar has underperformed," said Nemer. "They have activist investors that are pushing them to sell the company. You want to be the buyer. There are three big players, and you don't want to be No. 3."

2. Market

The pressure to consolidate follows the success that the dollar-store industry saw during, and since, the recession. Discounters tend to be defensive stocks. They remain stable through challenging economic environments as shoppers turn more frugal.

"The Great Recession caused a lot of people to reevaluate how they spend their money," said Nemer.

And consumers aren't quick to forget troubling times.

Despite the convenience of one-stop big-box shops such asTarget ( TGT ) and Wal-Mart, consumers are more willing to make "fill-in trips" outside of their routine shopping to seek out bargains at a variety of different stores to keep household expenses down.

"That's why (dollar stores) fare so well during the recession," said International Council of Shopping Centers spokesman Jesse Tron. "(But) there are still people that are very price conscious, and that speaks to why the segment continues to thrive."

"Basically, even post-recession there are still consumers that are looking at price, and what you're seeing is the same consumer making different trips, going to (big-box retailers) but also to discounters and also to traditional stores," he said.

A sharp advance among dollar store stocks since August has lifted IBD's Retail-Discount and Variety group to a number 16 ranking among 197 industry groups, up from No. 117 in late July. In addition to the big three dollar-store chains, rounding out the industry group areBig Lots (BIG), a closeout retailer that offers a broader range of prices and items that include furniture and electronics, and value retail chainFive Below (FIVE).

Five Below appeals to the teen and pre-teen market with trendy items priced between $1 and $5. The company reported second-quarter results on Sept. 10, with earnings rising 36.4% to 15 cents a share, beating analyst views by a penny, and revenue up 30.2% to $152.5 million, slightly topping.

3.Climate

Dollar stores over the past five years nibbled away at market share from big-box players Target and Wal-Mart. They placed stores strategically along high-traffic routes near the big boxes, and they invested to expand offerings of consumables. But Wal-Mart has begun fighting back.

"It's been very competitive lately," said Storms. "With Wal-Mart's new management, it's going to get more competitive."

She points to Wal-Mart's strategy of opening Neighborhood Markets, smaller-format stores more akin in size to dollar stores than big boxes.

The strategy is seeing some success. Wal-Mart reported Neighborhood Market Q2 same-store sales gains of 5.6% and traffic comps of 4.1%.

It also opened 22 new Neighborhood Markets during the quarter.

Nemer of Wells Fargo doesn't see these smaller-format Wal-Marts as an immediate threat but rather as something to be mindful of in the longer term. The Neighborhood Markets focus on groceries and fresh food, which don't overlap directly with dollar-store merchandise.

But dollar chains aren't taking the new tack for granted. The "big driver" at Dollar General has been its consumables sales, having added coolers and freezers in order to sell food, said Nemer. He reported in an Aug. 29 research note that food stamp funding cuts, increased health care costs and the unemployment rate contribute to ongoing pressure.

"We are less bullish on dollar stores and believe the low-end customer will remain under pressure in 2014," noted Nemer.

4. Outlook

Still, analysts don't see any alarming obstacles to dollar stores in the near term.

"We do think the growth stories remain pretty good for all of them," said Morningstar analyst Ken Perkins. "The other thing is that as they add new stores, they can reinvest cash flow."

Perkins says that the economy and competition are the two primary near-term concerns.

And while others have brought up the possibility of market saturation, he says that he is "not concerned."

The industry's primary concern is how the dollar-store buyout battle will play out.

According to Nemer, a Dollar General-Family Dollar deal would be more profitable than a Family Dollar-Dollar Tree deal.

Perkins agrees that there are more cost and merchandise synergy opportunities between the former two, while "there's not much that Dollar Tree would add."

But whether a Dollar General takeover of Family Dollar will pass muster with the FTC is another big question mark that leaves some analysts skeptical.

"The way I see it, if you're already getting the second degree from the FTC on companies with two different business models -- I don't know," mused Wedbush's Storms, who said that she doesn't see the Dollar General-Family Dollar merger happening.

"I think it's going to be a long road for Dollar General to acquire Family Dollar."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



This article appears in: Investing , Investing Ideas
Referenced Symbols: DG , DLTR , WMT , TGT


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