The one-percenters are now destroying dollar stores
The wealthy are raising prices on lower-income Americans, which is hurting bargain-basement retail stores
Associated Press
Occupy Wall Street may be long gone. But the ever-growing wealth gap remains a nagging challenge for the U.S. economy.
For a fresh reminder, just look at how a rolling “one-percenter” money grab is taking a toll on dollar stores. Those are the chains that bargain hard with suppliers and trim portion sizes so they can offer a lot of items for $1.
That model has worked well for years, as many shoppers with limited budgets rely on the stores for low-priced basic supplies. But recently the magic has faded. And one-percenters are partly to blame. The reason: They’ve been commandeering so much cash from the 99% crowd that they’ve helped topple this part of retail.
Shares of Dollar Tree DLTR, -0.26% and Dollar General DG, -0.13% the two biggest players in the dollar-store space, swooned 15%-22% in August-September. Surprisingly bad sales growth was to blame.
There’s no question that a big part of the problem was an ongoing wealth grab by the one-percenters from the less fortunate among the 99%-ers. Just listen to the CEOs of those companies explain what happened.
Rising rents and medical costs
Dollar General CEO Todd Vasos spends a lot of time in stores, and he looks at research to understand his customers. His conclusion: Their earnings are holding up OK, but their expenses keep going up a lot. And this is hurting his business. The chief culprits? Health-care costs and rent that are rising at a “very rapid” clip, he told investors in the company’s most recent conference call. “Our core consumer continues to be under a lot of pressure,” he said.
Bob Sasser, the CEO of Dollar Tree, tells the same story. Consumers, he says, are hurting, and like Vasos, he blames rent and health care. Rising costs in both areas are “the No. 1 issue that we see out there,” he says.
Now, the median income of the people being squeezed — the “average Joe” — was a mere $28,757 in 2014, according to the Federal Reserve Bank of St. Louis. And it hasn’t gone up much since.
In contrast, the health-care execs, landlords and doctors behind the price increases killing the budgets of the less well-off are quintessential one-percenters. Just consider the following.
* The median pay of CEOs at S&P 500 health insurers, hospital and pharma companies was $14.5 million last year, according to Equilar, a research firm that offers boardroom intelligence to clients.
* The incomes of landlords are no doubt all over the map. But the CEOs at four of the big publicly traded residential real estate companies made about $8.13 million on average in 2015, according to Equilar.
* Doctors earn anywhere from $204,000 to $443,000 a year depending on their specialty, according to Medscape, a division of WebMD WBMD, -1.75%
With earnings like that, do these one-percenters really need to keep squeezing the budgets of average shoppers so much that they have to cut back on basics like shampoo and toothpaste at $1 a pop?
You decide.
Low-end price wars
Indeed, one-percenters are wringing so much more cash out of the budgets of lower-income workers, it’s sparked a turf war among retailers who serve them. It’s a raging battle for what little these shoppers have left to spend.
This price war has retailers like Walmart WMT, -2.13% and Target TGT, -0.66% slashing prices. Dollar General is now doing the same to keep customers coming in the door.
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Dollar General recently cut prices by an average of 10% on 450 best-selling items, in 17% of its stores. It’s also offering $1 prices on more national brands. And it’s rolling out more private-label brands, which tend to be more affordable. Those include a brand with a healthier image called Heartland Harvest, to appeal to millennials.
Are dollar stores history?
A big problem for investors is that cutting prices isn’t necessarily a good way to boost earnings. Investors normally prefer pricing power. Plus, the ongoing squeeze on the budgets of lower-income people doesn’t really paint a favorable outlook for the dollar stores.
So, is it game over for these companies? Maybe not.
Executives at Dollar General and Dollar Tree recently bought significant amounts of their own company stock in the current selloff.
What do they see that’s bullish in this picture? The following four factors, which suggest it makes sense for long-term investors to buy these names.
1. Room to cut costs
Dollar Tree bought Family Dollar in July 2015, doubling its store base overnight. But there’s more to the story. Dollar Tree has much better profit margins, leaving plenty of room to boost margins at Family Dollar, points out Steve Goddard, a money manager at Richmond, Va.-based The London Co. who manages the Touchstone Mid-Cap Fund TMAPX, -2.86% He’s worth listening to because his fund significantly beat competitors over the past five years, and he has a big position in Dollar Tree. It’s his No. 1 holding.
If Dollar Tree can boost Family Dollar profit margins closer to its own, the company overall could see a 50%-100% increase in earnings over the next three years, maintains Goddard. That’s huge. Dollar Tree hopes to do this, in part, by improving procurement at Family Dollar, and sharing supply-chain and logistical services.
J.P. Morgan Chase JPM, -0.89% analyst Matthew Boss, who has an “overweight” rating on Dollar Tree stock, thinks these kinds of changes could help boost Dollar Tree shares to $107 by the end of 2017.
Dollar General has cost-cutting opportunities as well, which could help boost its stock to $97 in a year, according to Morgan Stanley MS, -1.40% analyst Vincent Sinisi, who has an “overweight” rating on the name.
2. Room to grow
Analysts and top execs at dollar stores still think there’s potential for thousands more of these stores in the U.S. OK, that sort of tells us what they think about the prospects for narrowing the wealth gap. But it also helps explain the recent insider buying in dollar-store names.
Dollar General management, for example, believes the U.S. market can support at least 13,000 new stores, on top of a current base of more than 12,400, notes Morningstar MORN, -1.64% analyst Erin Lash. “Dollar General is one of the rare firms in defensive retail with substantial new-store growth potential,” she says. It plans to add 900 stores this year, and 1,000 next year.
3. Food-price deflation may be over
The dollar stores cited steep declines in the prices of basics like milk, eggs, sugar, cereal and coffee as one reason for the slowdown in sales last quarter. But commodity prices are volatile. If the downward move is over, or they start heading back up, this will help with sales results.
4. A “food stamps” problem will fade
While one-percenters are grabbing more wealth from lower-wage earners in the form of huge price hikes for rent and health care, there’s a two-way street here. The wealthy pay the lion’s share of taxes. And a lot of that money flows to the less well-off, in the form of benefits. One of the big programs here is food stamps, or the Supplemental Nutrition Assistance Program (SNAP).
Recent changes in SNAP hurt the dollar stores. But the worst may be over, and investors selling now may not fully understand this.
Here’s what’s going on. The economy has done so well that by the start of this year, 22 states brought back a traditional three-month time limit on food stamps for anyone who is not disabled, raising children or working at least 20 hours a week.
That was a big change. The Center on Budget and Policy Priorities, a non-partisan think tank, says this means 500,000 to 1 million people would lose food stamps. The change began at the start of the year. So it effectively took its toll three months later, on April 1. That was right at the start of the second quarter, the dismal one that just sank the shares of dollar stores.
Both companies cited this as a factor in weak sales. Food stamps are used in about 5%, or less, of their sales. But the worst may be over, since the maximum three-month time limit kicked in Jan. 1.
Now there’s an improving chance that people who lost food stamps might find jobs. After all, unemployment is down to 4.9%. The share of small businesses (who do most of the hiring in the U.S.) with one or more job openings is at the highest level since 2001. It’s at 28%.
All of this suggests people who got moved off food stamps might find it easier to find at least part-time jobs. Sure, they are some of the hardest people to employ because of low skills, says the Government Accounting Office. But if it plays out this way, at least to some degree, it will help the dollar stores.
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