Dollar comps prove Teflon tough: going to extremes

DSN Retailing Today, July 5, 2004 by Debbie Howell

Extreme-value retailing has become one of the hottest growth segments of the decade, with dollar stores and closeout chains getting noticed by both consumers and investors as the niche matures and the largest operators grow profits.

As a group, the largest dollar stores, single-price retailers and closeout chains included in DSN Retailing Today's annual industry report grew sales 13.4% to $23 billion in 2003, with many noting double-digit gains in operating profits. Rapid growth of these mostly small-format stores has fueled the top line, such as that of Dollar General opening 675 stores a year--equating to almost two daily.

In recent years, the dollar-store industry's reputation has improved dramatically in response to higher product quality, the addition of national brands and brighter, more appealing stores. In turn, more middle-income shoppers are patronizing the channel as stores expand beyond rural and low-income markets to urban locales.

"These companies now have more professional management teams, they have systems, they have gotten better and have recognized national brands in the stores," said Joan Storms, a research analyst for Wedbush Morgan Securities of Los Angeles.

Despite strong growth in the sector, competitive pressure is heating up for the first time, presenting challenges for some operators. California-based 99 Cents Only, for example, expanded to Texas last year and did not achieve the sales volume anticipated, with stores in Houston and Dallas losing money in the first quarter. The presence of several rivals in that market--Family Dollar, Dollar General, Big Lots and Dollar Tree--along with Texans" unfamiliarity with the chain likely impacted results, although 99 Cents Only remains committed to Texas.

This scenario could crop up again as the largest players begin overlapping, especially in dense urban markets that have been a focus lately for expansion. That's not to say the extreme-value sector is nearing saturation, however, with market research firm Retail Forward projecting the United States can support 15,000 more stores. The top players operate more than 17,000 stores, and with independents included, that number rises to between 25,000 and 30,000 extreme-value stores in the United States.

"Even if the leading players sustain the rapid growth evidenced in recent years, the U.S. market saturation is still a ways off," noted a report on dollar stores by Retail Forward.

Analyst Mark Miller of William Blair & Company in Chicago agreed that years of expansion lie ahead for the sector, especially in markets such as California, which neither Family Dollar nor Dollar General have reached. Family Dollar itself estimates it can grow to some 10,000 stores in the United States, doubling in size.

"Typically when a sector might be approaching saturation you'll see returns diminishing. So far, there is no apparent weakening of aggregate returns," said Miller.

With a few exceptions, profit gains for the group are some of the highest in the retail industry, driven in part by efficient distribution systems, direct imports and other means of keeping costs low. Meanwhile, a changing mix is raising shopper frequency and the average ticket for some, with increasing reliance on food and consumables in the sector.

Coolers are becoming a popular addition, with Dollar General, Family Dollar and Fred's either testing or expanding such programs. 99 Cents Only has offered food for years, but also has expanded in this area.

Food as a percentage of sales has risen for most extreme-value retailers, ranging from 40% for 99 Cents Only to 12% for Dollar Tree. Dollar General has been the most aggressive in growing food lately, expanding both its pilot cooler program and a test format called Dollar General Market.

The market concept, twice the size of a regular store and featuring more grocery items, will expand from two to 22 stores this year. The grocery part of the format is similar to a limited-assortment food store, with most categories represented, including bakery, produce, dairy and meat. Separate from this test, Dollar General is rolling out a smaller cooler program to all stores over the next three years, featuring basic foods like milk, ice cream, frozen entrees and lunchmeat.

Though later to the game, Family Dollar has also begun testing coolers, as has regional operator Fred's. Family Dollar ceo Howard Levine told DSN Retailing Today earlier this year that the test could result in an expanded food offering.

"Food has been a growing part of our mix over the last few years and it is an important category for us,'" Levine said at the time. "'It seems like everybody is interested in broadening the food category. Ultimately, we'll have to see how that goes."

Storms said the expansion into perishable food adds complexities for dollar-store operators, including the fact that it's a lower-margin business with added expenses, food safety and shrink issues. But she understands the thinking behind the food frenzy, given that most types of convenience retailers at least sell milk.