Dollar Tree’s big Gamble on Family Dollar Pays off or Does It?

The huge gamble Dollar Tree (NASDAQ: DLTR) took; when it bought its ailing rival Family Dollar, last year is finally starting to pay off at least on paper.

Dollar Tree’s revenues more than doubled between July 2015 and July 2016; rising from $9.759 billion to $20.39 billion. That made for an increase of $10.631 billion in a year; and puts Dollar Tree in striking range of its archrival Dollar General (NYSE: DG). Dollar General reported revenues of $21.01 billion on July 31, 2016.

Among other things this means that Dollar Tree’s revenues now exceed those of Kohl’s (NYSE: KSS) and JC Penney (NYSE: JCP). For the record; Kohl’s had revenues of $18.97 billion; and Penney’s reported revenues of $12.62 billion, on July 31, 2016.

This means that Dollar Tree like Dollar General might be on the verge of becoming a major player in retail. It also shows us that the dollar store model is working, but is it profitable, is Dollar Tree making money?

Is Dollar Tree Making Money?

Dollar Tree is making some money it reported $713.8 million in net income and a profit margin of 3.41% on July 31. It also reported $189.3 million free cash flow and $1.486 billion in cash from operations on the same day.

What’s more interesting is that Dollar Tree had quite a bit of float, more than Dollar General. Dollar reported assets of $16.33 billion and cash and short-term investments of $1.097 billion on July 31, 2016. In contrast Dollar General reported $185.03 million in cash and short-term investments and assets of $11.62 billion on the same day.

That means Dollar Tree is cash rich for a retailer but that might not last. There is some evidence that its potential market is shrinking.

Dollar Stores face Shrinking Customer Base, Growing Competition

Both Dollar Tree CEO Bob Sasser and Dollar General CEO Todd Vasos admitted that their customer have less money to spend; because of rising rent and healthcare costs for lower-income people. Those lower-income people have less disposable income and they are the dollar stores’ primary customer base.

Some observers; such as Market Watch writer Michael Brush writer, think the situation is getting worse because of growing income inequality and wage stagnation. Brush’s contention is that the potential market for dollar stores is shrinking because of rising rent and health care costs. Disturbingly both Vasos and Sasser agree with Brush’s contention.

That comes at a time when other retailers such as Walmart (NYSE: WMT) and Kroger (NYSE: KR) are squeezing dollar stores with lower prices. Another bottom feeding retailer the German-owned privately held Aldi is growing fast.

How Jet could Threaten Dollar Tree and Dollar General

It also comes at a time when competition in the lower-end retail sector is heating up. Aldi is expanding nationwide and Jet.com is taking online discounting to a new level. Jet.com; which was acquired by Walmart in August, is a major threat to dollar stores because it offers escalating price increases for bulk buying and easy to take advantage of free shipping deals.

Online discounters like Jet.com are a major threat to dollar stores; because they lure away middle and upper income customers that small box retailers desperately need right now. Part of the threat presented by online retailers is that they allow upper class shoppers to bargain hunt without going to the dollar store.

The dollar store is no fun to shop at and many people are embarrassed by going there. Affluent shoppers don’t have to worry about their friends from the country club seeing their car in the Family Dollar parking lot, when they buy from Amazon or Jet.com.

Another threat is that Jet.com competes directly with Dollar General and Dollar Family in rural markets; that make up a large portion of their footprints. Much of Dollar General’s clientele consists of people who don’t feel like driving 50 miles to buy laundry detergent. Now Jet.com, Walmart.com and Amazon let those people buy laundry detergent at a lower price than the dollar store, and offer free shipping.

Is Dollar Tree a Good Investment?

All this means that dollar stores are a risky investment; because they are in a niche market with growing competition. A particular threat here is that dollar stores might be forced to dramatically cut prices and potential profits to stay competitive.

Dollar General recently cut prices on 450 bestselling items by 10% in 17% of its stores, Brush noted. The cuts are designed to match deep discounting at companies like Kroger, Amazon and Walmart. The problem is that those companies’ resources greatly exceed the dollar stores.

Kroger reported revenues of $111.38 billion on April 30, 2016; Walmart reported revenues of $483.83 billion on July 31, 2016, and Amazon reported revenues of $120.64 billion on June 30, 2016. That means those companies can afford much deeper discounts than Dollar General and Family Dollar.

One major threat is targeted price cuts designed to hurt dollar stores. Kroger actually seems to be doing this in some markets; by offering lower prices on some items sold at dollar stores like canned tomatoes.

This means we might see lower net incomes and profit margins at the dollar stores. A dilemma Dollar Tree might face is being forced to raise prices to cover costs; at a time when Aldi, Walmart and Kroger are undercutting its prices.

My take is that both Dollar Tree and Dollar General are overpriced stocks. Dollar Tree is a slightly safer investment because it has more cash but neither is a good long-term investment. The market they are in is simply too competitive and unstable to support their business models.

Expect to see major share price collapses and possibly the death spiral at either of these dollar store operators. Their growth simply is not sustainable in today’s retail environment.