Can Investors Still Cash In on $8.5 Billion Dollar Store Deal?

Can Investors Still Cash In on $8.5 Billion Dollar Store Deal?


For dollar stores, weak is strong and strong is weak. Back in the days when the economic recovery was still tenuous, dollar stores were the only place that many families could afford to shop. Same-store sales boomed at chains like Family Dollar Stores, Dollar Tree Stores and Dollarama. Between July 2009 and July 2011, the stocks of those companies returned about five times the Dow Jones Retail Titans 30 Index. Even laggards like Dollar General, which soared 38 percent in that period, fared twice as well as the S&P 500 index.

But the outperformance of dollar stores has been less marked with every passing year. Since 2012, the Retail Titans Index has returned 33.85 percent, while the dollar stores, with the exception of Dollarama, struggled to break into single digits. Stocks like Macy’s and Gap replaced them as winners for investors looking for retail holdings — and Wal-Mart, Target and other big department stores began to vie aggressively for a share of their business.

Related: Dollar Tree to Buy Family Dollar to Stave Off Competition

That’s the backdrop against which Dollar Tree and Family Dollar proposed an $8.5 billion merger this week. It’s a marriage that, if consummated, would result in the formation of a behemoth with $18 billion in annual sales and 13,000 locations across North America, in urban, suburban and rural markets.

The logic for the move is clear. Family Dollar has struggled to compete, both against its dollar-store rivals as well as the likes of Wal-Mart. Its margins are half the levels of its rivals; its same-stores sales have fallen. Part of the problem, analysts have said, is that it opened up too many stores too rapidly, sacrificing margins for growth; nor was its operating cash flow adequate on its own to finance all that expansion.

By late 2012, the writing was already on the wall, as inventory began to climb and the retailer started marking down goods: a clear sign of trouble at a retailer that already prices its goods with razor-thin margins. The arrival on the scene of activist investor Carl Icahn, demanding that the company put itself on the block, was simply the last straw. Icahn has probably done well on his investment, for which he paid an average price of $58.20: Dollar Tree will pay $74.50 apiece for those shares, a 23 percent premium to where they changed hands as of last Friday’s close, before the transaction was announced on Monday.

Related: 5 Reasons to Be Optimistic About Economic Growth

The question now is what lies ahead for the dollar store space as a whole. Frankly, the picture isn’t all that rosy. True, the newly merged Dollar Tree/Family Dollar entity will be in a stronger position when it comes to haggling with suppliers, leveraging greater collective clout for discounts. But that only addresses about a quarter of the issues that will shape the future of the segment, issues that the new power player will have to grapple with even as it oversees the integration of the two companies — never an easy task at the best of times. And this, for dollar stores, isn’t the best of times.

Dollar stores, tempted by the boom that they witnessed in sales, have over expanded. That means they’ll either have to trim their sales, or invest more heavily in marketing, or find ways to diversify their product lines to appeal to new customers. None of these are easy.

Few dollar stores expected the kind of unhappy economic recovery that we have witnessed: one in which those occupying the bottom rung of the ladder have failed almost entirely to feel any benefit. So, even as some consumers turned to dollar stores temporarily during the recession and may be returning to shop elsewhere now that times are better, the customers who can be relied on to keep shopping at dollar stores have fewer dollars to spend. Family Dollar had tried to boost prices on some items, a poorly conceived and badly timed idea that backfired with its cash-strapped customers and resulted in a dreadful earnings report earlier this month.

Related: Gallup Finds Stunning Drop in Consumer Confidence

Then, too, there is the tremendous competition for those shoppers, not just from the dollar stores but from big-box retailers and even supermarkets and drugstores like Walgreen’s. The lines that once separated these stores are blurring fast, and the goal, increasingly, is simply to tempt the shopper inside the doors by promising her an array of unbeatable prices on key items, general value pricing and a one-stop, convenient experience. And who’s to say that the dollar stores — monikers aside — even offer the best prices?

Some have suggested Dollar General, whose stock has struggled so far this year and is flat in the wake of the merger announcement is an appealing buy. Not likely. It may still be in expansion mode, but it’s going to be facing the same set of headwinds as every other retailer that caters to the most cash-strapped set of consumers in the country.

For this retailer, and its peers, the economy’s improvement just means that some of its customers have more options — and the remainder have no more spending power than before. Not a recipe for blockbuster returns.

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