Physical retail stores as a whole in most developed countries have more likely than not reached their peak. However, there is a sub-category in this sector that is expanding quickly. More than that, the so-called “dollar stores” have even been beneficiaries of a diminishing middle-class. Are the respective stocks a good investment idea, especially as inflation is trimming budgets?

Summary and key takeaways from today’s Weekly
– The businesses of dollar stores are not only interesting, they are also strong on margins and have higher growth than the big, established retailers.
– However, they used more debt, especially to finance the big expansions of the last decade.
– Valuations imply that more growth is priced in. Even with buybacks, I miss a margin of safety, as these stocks seem to be fully priced – not discounted.

Who doesn’t like to pay low prices? Certainly, many wouldn’t complain to feel like a hard-core frugalist after having done a good deal that saved some hard earned dollars. 

Here come certain types of physical stores into play that offer cheap and discounted prices. I am not talking about ordinary stores or supermarkets that sometimes give you a rebate or have weekly changing promotions to draw in consumers. It is also not about discount supermarkets like Aldi.

Today’s Weekly centers around another special type of retail stores that always offer the lowest possible prices – at least so goes the promise. These are called “dollar stores” (or “one euro stores” here in Germany). Even though one dollar or euro is not the maximum price anymore, those names stayed partly officially and partly in common parlance to stress the cheapness of the sold goods. 

Many countries have such stores. Here in Germany for example known representatives are Kik or TEDi, although both officially are not one euro stores. However, the concept and the products sold are mainly the same, with some differences. Unfortunately, both are not stock market listed. 

In North America, we have more to choose from, at least when it comes to potential stock investments. There, we have two interesting companies in the USA and also one in Canada that is even expanding into other geographies.

The stocks of these companies have done very well since becoming public. More recently, the businesses even experienced a boosting tailwind from the fundamental and economical side of things. It is a sad fact that middle-classes are shrinking and descending (see here). 

One man’s sorrow is another man’s joy. 

It is no wonder that these types of stores, also referred to as “value retail” are rapidly expanding, although in general physical retail stores should have reached already their point of saturation in many places. Discount stores or dollar stores, however, have still room to grow and are doing so rather aggressively. 

Are these stocks worth a look or even a long-term investment?

These companies are not only growing faster than conventional retail stores, but to the surprise of many, they are even way more profitable than their larger competitors from higher price segments. Yes, also higher and better than the king of retail, Walmart (ISIN: US9311421039, Ticker: WMT).

Let’s have a look if a few bucks can be made using discounts.

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History and concept of dollar stores

for sources, see here, here, here, here, here and here

The most known active dollar store brands in North America today are: 

• Dollar General (ISIN: US2566771059, Ticker: DG)
• Dollar Tree (ISIN: US2567461080, Ticker: DLTR)
• Family Dollar (bought by Dollar Tree)
• Dollarama (ISIN: CA25675T1075, Ticker: DOL)

The first three are from the USA and were founded in the 1950s. The biggest of these, Dollar General, is also expanding into Mexico. Dollar Tree has likewise operations in Canada, where Dollarama, the late-comer of the pack, comes from (founded in the 1990s). 

What led to the successful expansions was more or less the same. 

Ambitious founders that created simplified, but optically unexciting stores. What was exciting, however, was the pricing policy, the promise to always find bargains and to save money compared to “usual” stores.

All dollar store chains operate by the same concept and basic idea of simplicity. 

They want to be recognized immediately and known what they stand for – affordability and low prices. A customer shall feel familiar and not overwhelmed. Everyday bargains can be made because there are no special promotions (except maybe shortly before expiry of a good).

This concept shall not be confused with a charitable organization. These businesses are there to make money from their operations, not to donate stuff.

The picture below shows how such a store can look like, although it is none of the brands mentioned above, as you will likely see by the price tags. However, the optics go in that direction:

All stores are to a large degree standardized, this includes, among other things:

• stores are most often located in rural areas, not in the centre of a town to save on leasing costs
• more often than not, there is barely any competition in the directly surrounding areas
• the stores are neither flashy nor highly advertised; quasi the anti-Walmarts
• whereas in some stores you pay for the customer experience, i.e. the consulting, the presentation of certain goods and also possibilities to taste something before buying, dollar stores have nothing of that; they have fluorescent light and are reduced to the absolute minimum
• all stores look at least similar and are of comparable sizes, although in the most recent past the average store size has increased somewhat
• the available space is rather used to a maximum efficiency, as many corridors tend to be slim
• dollar stores sell non-perishable or long durable goods like cans, candies, bottles, sodas or household goods and no fresh produce (but this is changing slowly, we’ll have to see if it prevails)
• often there are not many varieties to chose from a product
• pricing is structured in a way that their offerings are associated as discounted and always low with many items selling for a dollar or less
• discounted is not necessarily cheap or low-quality, however, one should not expect the highest quality, either. Decent-enough, though. 
• dollar stores source many goods in bulk quantities directly from China and cut out wholesalers

The goal behind this concept is to draw in customers not necessarily for their weekly big groceries shopping you usually do in a supermarket, but even this is an emerging trend. It is more about all other items to “fill-in” the weekly grocery shopping trips and includes also a treasure hunting experience. 

Once you are in, why not pick up one or two other items for a dollar?

Impulse buying, i.e. buying something you have just seen without originally wanting to buy it, is a factor that should not be underestimated, as it creates additional sales.

According to a consumer report, even surprisingly for me, the vast majority of Americans sees themselves as regular visitors and shoppers in such dollar stores, as the following graphic shows:

What about the growth of such dollar stores? 

In 2021, the total figure of retail value stores was around 35,000 in the USA (see here). Out of that, the market leader, Dollar General, has slightly more than half of it, with more than 18,000 stores. Note also the speed of the expansion on the graphic below:

In 15 years, the total amount of Dollar General stores, doubled. 

Before looking at the statistics, my guess would have been that this is a nice figure, but certainly still slightly behind Walmart.

Guess what, I couldn’t have been more wrong on this one.

The following picture not only shows that Dollar General has absolutely more stores than Walmart, but the speed of the growth is as astonishing as the fact that WMT seems to have peaked already five years ago:

And there is still room to grow? 

It seems so, because the expansion plans of the companies suggest it. In this fiscal year alone, Dollar General wants to have opened up 1,050 new stores. That is easily 10% of what Walmart has in total stores worldwide. 

Likewise in Canada, Dollarama plans to up its store count by a third until 2029. Currently, there are less than 1,500 dollar stores. It shall be 2,000 by then.

A slightly provocative thesis be me: Maybe dollar stores are the real disruptors of the physical retail industry?

What I’ve found also interesting is that there are more dollar stores in the USA than McDonald’s and Starbucks branches – combined, of course!

A last surprising fact: Most people live closer to a Dollar General store than to a hospital.

Like most sectors, also dollar stores have to cope with inflation in their operations. In their case, it is even more so critical, as they were rather reluctant in the past to up the one dollar price “limit” to let’s say two or five dollars.

To solve the issue, many workarounds have been identified and implemented. 

Besides actually offering products for more than a dollar “quietly”, the main association as dollar stores stayed. The businesses were able to increase prices slightly, because their higher priced competitors had to so, either. Or they just don’t make a secret out of it and say, prices are not the same. However, you can count on us to offer you the best possible prices everyday!

But also, there are some tricks to hide factual price increases like shrinking the volume of a package or instead offering a pack of 5, now there are 4 or even 3+1 to make it look like one was as a bonus. For the same price, to be clear!

Three stocks on the test rig – deal or no deal?

First, here are some charts to show you the performance of the stocks of dollar stores. Note that they did not go public at the same time:

Stock of the next one, Dollar Tree, could have even been bought for a dollar and some pennies during the 1990s!

And here are all three in local currencies and without dividends since their longest time together on the stock markets: 

Who says that investments have to be complicated or carry around something with “digital” or “tech” to be successful? 

Not only that: These stocks also have not participated in this year’s bear broader bear market! To the contrary, they are in reach of their all-time highs!

Now, that we looked from a bird’s eye view at the general business model and the performance of those stocks, let’s compare some fundamentals of these businesses.

It may surprise many, that these discount stores that are selling stuff for a few dollars (I refrained from writing “for pennies”), not only have higher margins than for example Walmart or Target (ISIN: US87612E1064, Ticker: TGT). They also are growing faster.

To show you that these weren’t just bold claims, here are the hard figures.

The first chart shows you the evolution of the operating margins of Dollar General, Dollar Tree, Dollarama as dollar stores in comparison to Walmart and Target:

We see three big results:

• Dollarama from Canada has by far the highest operating margins and was even able to raise them over the last decade
• quite the opposite at the bottom, where Walmart not only has the weakest operating margins, they also declined
• the rest is somewhere in the middle, however, Dollar General keeps place number two with an operating margin that is double as high as Walmart’s

What about free cash flow margins?

It is more or less the same picture. However, Dollar Tree here has the last place. But Dollarama ist still top-notch, as much as Dollar General is second and has way higher margins than Walmart.

Over the last ten year, revenues developed as follows:

• Dollar General: +126% (8.5% p.a.)
• Dollar Tree: +274% (14.1% p.a.)
  (however, included is inorganic growth from the Family Dollar acquisition)
• Dollarama: +159% (10% p.a.)
• Walmart: +28% (2.5% p.a.)
• Target: +49% (4.1% p.a.)

Whether organic or not, overall growth is way higher (2–3x) at the dollar stores. 

Their market capitalizations are also way lower, hence there is more room to grow from that front, too.

Last category for a brief overview of the quality of the businesses: return on capital. It tells us whether the earnings were achieved using little or much capital (equity and debt).

Here, we have a slightly different picture.

Because Dollarama and Dollar General are higher leveraged (and thus have more total capital in the denominator), their returns on capital are closer to the rest. On the other side, Walmart and Target have less debt and thus higher or equal returns on capital.

With the negative exception of Dollar Tree again (which gets pressure from an activist investor), all these operations are of high quality.

The dollar stores are using more leverage. 

This brings us to the next point, as I am not a friend of having a leveraged balance sheet in the current times, because refinancing will inevitably come and force the companies to pay higher interests. This will shrink net margins and cash flows.

The following table shows the evolution of the debt levels over the last decade. I use net debt to EBITDA here, because it is the number they are reporting and set their debt targets using this number. As you know, I don’t like EBITDA, but it is okay here to capture the broad trend for comparison reasons.

Company	Net Debt /  EBITDA 2013	Net Debt /  EBITDA 2022 (last reported)
Dollar General	1.3x	2.8x
Dollar Tree	net cash	2.0x
Dollarama	0.6x	2.9x
Walmart	1.3x	1.5x
Target	2.2x	2.3x

^{source: TIKR.com}

The dollar store companies all heavily loaded up on debt and stretched their balance sheets, while Walmart and Target mainly kept their debt ratios stable in relative terms.

To be clear: These are stable and robust businesses that can allow to carry around some debt. Also, they are all somewhere around their target ranges of 2–3x net debt / EBITDA. But, they will have to spend from now on more capital either on net repayments or on higher interests.

The dollar stores mainly used the debt to finance their aggressive operations. Now that refinancing will become more expensive, the question will be whether the big ambitions will be achievable. 

What all these companies also do is buying back their shares consistently.

Company	diluted shares 2013	diluted shares 2022 (last reported)	reduction
Dollar General	334 mn.	228 mn.	–32%
Dollar Tree	230 mn.	225 mn.	–2%
Dollarama	451 mn.	293 mn.	–35%
Walmart	3.389 mn.	2.752 mn.	–19%
Target	663 mn.	469 mn.	–29%

^{source: TIKR.com}

I think at some point, if interest rates stay elevated, the dollar store companies will either have to dial down somewhat on their expansion plans or they will reduce their buybacks.

The last thing in this broad overview is the valuation factor.

So, let’s have a look at some recent metrics:

Company	EV / Sales	EV / FCF	dividend yield
Dollar General	2.0x	neg.	0.8%
Dollar Tree	1.5%	neg.	no dividend
Dollarama	5.6x	59x	0.3%
Walmart	0.8x	95x	1.6%
Target	0.8x	neg.	2.6%

^{source: TIKR.com}

As a rule of thumb, if you have a good-quality retail business, it is worth a look at an EV / Sales multiple below 1x. Better closer to 0.5x. Only WMT and TGT are currently slightly “on sale” according to this. But they have problems with cash flows, as inventories could not be sold and ballooned. 

No sales, no cash (flow). 

The dividend yields aren’t interesting either. But, should inventories and cash flows normalize, it could be time to have a second look for those, that are interested in such quality companies. 

However, I lack the imagination of WMT growing that much. That’s why it has to be at a really good price. A sales multiple of 0.5x could be interesting.

The dollar stores have the same problems. 

They also have too high inventories which pushed down cash flows. The dividend yields can be ignored, as these companies are not typical dividend stocks. They focus primarily on stock buybacks. However, the sales multiples already show that some growth seems to be priced in. 

I would be cautious here, as some disappointment could be around the corner. 2021 and 2022 were prime examples of what happens when ambitious growth targets are priced in, but fail to materialize…

No hurry! 

I don’t like the PE ratio that much, because you cannot read weak cash flows or high leverage from it. 

But as we have already looked at these two critical points and to add one factor more to the valuation, here are the PE ratios of the companies:

Company	PE ratio
Dollar General	24x
Dollar Tree	20x
Dollarama	31x
Walmart	44x
Target	20x

^{source: TIKR.com}

It is difficult for me to see any bargains at this front.

I would rather stay on the sidelines and watch valuations together with inventory and cash flow developments. At the moment, there is no need to rush.

Conclusion

The businesses of dollar stores are not only interesting, they are also strong on margins and have higher growth than the big, established retailers.

However, they used more debt, especially to finance the big expansions of the last decade.

Valuations imply that more growth is priced in. Even with buybacks, I miss a margin of safety, as these stocks seem to be fully priced – not discounted.

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