Could Aldi Kill the Dollar Stores?

There’s a major new player in American discounting that could quickly kill off dollar stores like Dollar General (NYSE: DG) and Dollar Tree Stores (NASDAQ: DLTR). It’s Aldi, the bottom-feeding German discount grocer that has developed a cult-like following in some circles.

The best way to think of Aldi is as a Trader Joe’s for the working class. Like Trader Joe’s, Aldi offers a limited selection of high-quality store-brand products at a low price. For example, it offers only one quality Aldi brand of ketchup or salad dressing. Aldi outlets in the United States also sell some name brand products at low prices. This allows Aldi to keep prices low because it has tremendous leverage over suppliers.

Aldi’s stores are also smaller, averaging 16,400 square feet in area compared to the average Kroger (NYSE: KR) store, which contains about 100,000 square feet of space. Aldi can get away with operating smaller stores because it has a limited selection and it forgoes some of the frills found in American supermarkets, such as banks, pharmacies, delis and health clinics.

Like Dollar General and Family Dollar, Aldi keeps costs down by having a much smaller staff. It also has some peculiar quirks, such as charging customers a 25¢ cart rental fee and not accepting credit cards. The customer gets the quarter back if he or she returns the cart. The idea here is to not pay an employee to go out into the parking lot and collect carts every few minutes.

Aldi has something else in common with Trader Joe’s: It is privately owned by a German company, called Aldi Sud. Trader Joe’s is owned by Aldi’s sister company, Aldi Nord. Both companies are loosely affiliated in the Aldi Group, which is owned by a sort of trust called the Siepmann Foundation. The Siepmann Foundation benefits the Albrecht Family, the heirs of the chain’s founders. If you are interested in Aldi’s history and its worldwide operations, this Wikipedia entry has a lot of good information.

Aldi Threatens Dollar Stores, Not Walmart and Kroger

A popular theory advanced by Seeking Alpha contributor Collective Investment Company is that Aldi threatens American supermarket operators like Walmart Stores Inc. (NYSE: WMT), the privately held Safeway and Kroger. There is some merit to this idea, but Aldi is a far greater threat to the dollar stores.

The biggest danger here is that Aldi offers a wide variety of items that dollar stores do not. For example, it sells fresh fruit, fresh vegetables and fresh meat. American Aldi outlets also offer some name brand products such as Pringles potato chips at low prices. Aldi also offers a range of non-grocery items that you might not find in dollar stores, such as small appliances, kitchen utensils and even walkers for the infirm.

From Aldi’s weekly ads, these items appear to be of a higher quality than those found at my local Family Dollar—a Dollar Tree subsidiary. This means Aldi offers higher quality and a greater selection than dollar stores do at a similar price.

How Aldi Is Cashing In on Income Inequality

Aldi is also cashing in on America’s growing income inequality like dollar stores do. Between 2007 and 2013 annual U.S. household income fell by $4,497, dropping from $56,436 to $51,939, according to the U.S. Census Bureau. Americans have less to spend, so they’re doing more bargain hunting and penny pinching.

Like dollar stores, Aldi accepts food stamps, an important source of income for the working poor. Around 45.7 million Americans, or nearly one in five people in the nation, was receiving food stamps in May 2015, according to USA Today.

Another way Aldi is capitalizing upon income inequality is by invading dollar stores’ home turf in the heartland. There are no Aldi outlets in my relatively prosperous home state of Colorado, but they can be found in stagnating places on the Great Plains such as Hutchinson, Kansas, and Rustbelt cities like Peoria, Illinois, and Akron, Ohio.

Why Aldi Is No Threat to Kroger

Collective Investment Company’s theory is that Aldi could be a threat to Kroger and Walmart because of its disruption of the British grocery market. Kantar WorldPanel estimated that Aldi’s share of grocery sales in the United Kingdom went from 3% in November 2012 to 5% in February 2015.

Aldi has succeeded in taking market share from the biggest British grocer Tesco (NASDAQ: TESO), its market share from 30.6% to 28.3% over the past few years. Repeating that feat might not be so easy in the USA because Walmart and Kroger are formidable and well-established competitors that seem to be ready for Aldi.

Kroger in particular is capable of deep discounting at the Aldi level. Some of its house brands sell at competitive prices to Aldi’s; for example, last week I purchased broth at City Market (my area Kroger brand) for 49¢ a can and coffee for $5.99 a can. City Market was also selling 16 ounces of Kroger brand peanuts for $1.79. Aldi’s house brand of peanuts was selling at a price of $1.99 for 16 ounces.

It looks as if Kroger has a buying capacity similar to Aldi and the capacity to sell house brands at a similar discount. Kroger can also offer a wide variety of amenities that Aldi lacks, including pharmacies, gas stations, banks and financial services, in its stores. The fuel discounts provided by Kroger’s reward card program could also be a major threat to Aldi; I saved 40¢ a gallon on gas with such a card recently.

My impression is that Aldi will have a hard time competing head to head with Kroger. Aldi itself seems to believe that as well; its expansion seems to be directed in areas where Kroger does not operate, including many working-class areas and small towns that Kroger has shunned in recent years.

Walmart Has Cloned Aldi

Walmart has gone further by effectively cloning Aldi with its Walmart Neighborhood Market concept. Neighborhood Market is a discount grocery store that looks a lot like Aldi. There are a few differences, including greater selection, the presence of pharmacies and the acceptance of almost every kind of payment, including credit cards.

Judging from my last visit to Neighborhood Market, Walmart has created a slightly bigger and better Aldi. Walmart is committed to the concept, with plans to open 85 new Neighborhood Markets by February 2017. Tellingly, the discount colossus decided to shut down all 102 of its Walmart Express dollar store experiments, some of which will be converted to Neighborhood Markets.

It looks as if Walmart, like Kroger, has figured out how to cope with Aldi. That does not mean Aldi will not become a major player in the U.S. grocery business, because it is already well on the way there.

Aldi Is Already a Major Player in the U.S. Grocery Market

There are already around 1,600 Aldi stores in the U.S. with a major expansion to Southern California in the works. Aldi is here in America, it is here to stay and it will disrupt the grocery market.

The major victims of Aldi’s expansion in the U.S. will be dollar stores and regional grocers, which have a very low operating margin. Dollar General, for example, reported a free cash flow of $83.66 million on a TTM revenue of $20.02 billion on October 31, 2015. Dollar Tree had a negative cash flow of -$174.4 million on revenues of $12.61 billion on the same day.

Judging by those numbers, Aldi could devastate a company like Dollar General by taking just 3% of its business. Walmart and Kroger, on the other hand, can afford to compete with Aldi. On October 31, 2015, Walmart reported a TTM revenue of $484.03 billion, and Kroger had revenues of $108.87 billion.

Regional grocers are in even worse shape; a big one, Roundy’s in Wisconsin, has sold itself to Kroger to avoid collapse. That means Aldi might actually help Kroger by driving more grocers to sell out to the monster from Cincinnati.

Aldi is a potent force that is already changing the American grocery business. It may not threaten the big guys, but Aldi will certainly change how and where Americans shop for milk and potato chips.