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Dollar Stores Defy Retail Headwinds

There are a few common themes in retail circles these days that are hitting nearly every store, whether fashion retailers, video games or athletic wear. Online retailers are upturning the industry, and many companies are reducing the growth of new stores to counter online growth.

None of these trends, however, have really impacted the lowest-priced retailers, the dollar stores.

And their business is booming.

For stores like Dollar General Corp. (ticker: DG) and Dollar Tree (DLTR), increases in the minimum wage across many states, cheap gasoline and lower unemployment have helped their core customers. And since the recession, these stores benefited from customers looking for a deal on something they would have previously purchased in a pharmacy or Wal-Mart Stores (WMT).

And the likes of (AMZN) hasn't shown much incentive in targeting dollar stores' typical customers. This has led to a 162 percent increase in stock price for Dollar General over the past five years and a 185 percent bump for Dollar Tree, compared to 58 percent increase for the Standard & Poor's 500 index.

But has the time come for the dollar stores to finally reverse?

More stores, but they're smaller. Dollar General started 2016 with an announcement that instead of opening 900 stores this year, it planned to open 1,000. It's expanding its physical presence while still "driving higher same-store sales," says S&P Capital IQ analyst Efraim Levy.

The fear among analysts is that Dollar General will grow too fast or open new stores too close to current locations, which would hurt sales. That hasn't happened, yet, in part because many of the new stores are less than 6,000 square feet.

The typical Dollar General store has a 7,400-square-foot design, says Patrick McKeever, a managing director with MKM Partners. But with 80 of the new stores planned for a smaller configuration, Dollar General appears set to cater to customers in urban, congested neighborhoods.

More people equals more customers.

More consumables on shelves. Another way Dollar General has managed to increase its same-store sales was by introducing tobacco to stores in 2013. The consumables category – which is made up of food, cleaning products, perishables and other consumer-centric items – accounts for 76 percent of sales. It has grown 7.9 percent in 2015, following an 8.8 percent growth in 2014.

Products such as tobacco, food and beverages encourage repeat shoppers. While Dollar Tree draws customers by stocking its shelves with $1 items that change regularly, Dollar General sells items that families need on a weekly basis in hopes of encouraging repeat customers. "It is fun to find a deal," Levy says, but you "also need your Ajax."

These efforts to create repeat customers give Dollar General clear growth opportunities, but with a 2016 price-to-earnings ratio of 21.1 compared to the industry average of 17.4, it may be too late to find the best deal.

Dollar Tree's acquisition. Dollar Tree completed its acquisition of Family Dollar – the third of the triumvirate of massive dollar stores – in July 2015. But it was expensive – a bidding war with Dollar General pushed the purchase price all the way to $8.5 billion. Now that the deal is closed, how will Dollar Tree incorporate Family Dollar into the mold?

Family Dollar won't be copying the Dollar Tree pricing formula, where seasonal and variety categories account for about 50 percent of sales. The merchandising mix frequently changes, creating "a treasure hunt experience," says Nick Mitchell, managing director of research at Northcoast Research. "The Dollar Tree does not have a direct competitor."

Dollar Tree officials are on target to implement $300 million in cost savings between the two companies. They've done a good job "in the early innings," Mitchell says.

Whether you think Dollar Tree can effectively incorporate Family Dollar into the fold will dictate whether you believe the stock price is enticing. "It's not overly expensive, but it's not very attractive either," Mitchell says.

By Ryan Derousseau | Contributor April 20, 2016, at 9:25 a.m.

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