A Surprising New Boost for Dollar Stores -- Ahead of the Tape

By Steven Russolillo 

A dollar goes a long way these days.

Dollar General Corp. and Dollar Tree Inc. have been big winners in the stock market, up more than 20% over the past year on strong sales growth and higher store traffic. Rising wages among their core clientele suggest the good times may continue as both companies gear up to release second-quarter earnings reports, expected Thursday.

The dollar chains thrived during and after the recession and have built on those days. Dollar General has added more items priced between $1 and $5, boosting its margins. And Dollar Tree bought rival Family Dollar, which it is still integrating a year after the $9 billion deal was completed.

Both have embraced the smaller-store format, which typically generates positive cash flow at a faster rate than other retail locations. And they don't seem to be threatened as much by the likes of Amazon.com Inc., or even Wal-Mart Stores Inc., as other retailers.

The tight job market is providing another boost. Weekly wages for full-time American workers in the bottom quarter of the income scale rose 3.1% in the second quarter from a year ago. That marked the sharpest increase since 2009, according to the Labor Department. Dollar General chief Todd Vasos acknowledged this on an earnings call in May, saying shoppers are "probably feeling a little more confident and spending a little bit more."

Both companies have expanded their selection of discretionary products, such as home goods and beauty products. This is a sign of confidence that they see their customers being more able and willing to spend.

The risk is the customers move to more mainstream retailers. That is unlikely because dollar chains typically serve lower-income neighborhoods whose residents make frequent, small purchases.

The question now is whether these stocks have rallied too far. Both surged to records following their previous earnings reports in May and have added to gains since. And both sport premium multiples relative to the S&P 500. Dollar General fetches about 19 times projected earnings over the next 12 months, a 20% discount to Dollar Tree.

Hefty valuations shouldn't scare investors. It doesn't look like this buck will break anytime soon.

(END) Dow Jones Newswires

August 24, 2016 15:26 ET (19:26 GMT)

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