Dollar-Sign-Up-iStock_000013528423XSmall-300x250The corner grocery store – owner-operated, never the same store when you were traveling — has evolved into the corner or strip mall convenience store or the super market or the super center a la Target or Wal-Mart (WMT). And it has evolved again – into the New American Grocery Store. These new stores are springing up everywhere. They are national chains and you know them as something other than a grocery store.

They are the dollar stores: Dollar Tree (DLTR), Dollar General (DG), Family Dollar (FDO). They are a critical component of my investing thesis The New Frugal, part of my free e-book Contrarian Profits  and their success is undeniable — and growing.

Once purveyors of Japanese, then Korean, then Chinese plastic junk and remaindered food items from places like Romania, the dollar stores are now real grocery stores, the old-fashioned kind with limited selections but real brands, fresh produce and dairy products.

I discovered this new kind of store the old fashioned way, by accident. I was buying to donate bulk items for a local charity (it gets food and clothing readily enough, but simple items like soap and shampoo and toothpaste are also beyond the reach of many of the poor).  So there I was at my local Dollar General, the store  at Federal Plaza in Rockville, Md.  Rockville is a few miles outside of Washington, D.C., in Montgomery County, Md., which still has a relatively strong economy and a real estate market with rising prices. Not everyone is sharing in this strength.

The store – old, filthy, crowded – was out of shopping carts and there was a line to get into the store. The product mix had changed in the past few weeks – more holiday stuff and more grocery and personal-hygiene products.  The clientele was very different – it was the day many retirees receive social security and other checks – and more than half the people were clearly of retirement age. They were shopping cautiously and carefully – I spent at least an hour in the store – and many had clothes far better than the younger people shopping for a wider variety of items. And they were mostly buying food.

Dollar stores reinvented

Dollar stores, simply put, ain’t what they used to be. One of the highlights for my sons on our beach vacations was a visit to a newer, larger-sized dollar store where they could take a $5 bill invariably sneaked to them by their grandmother and they could buy a lot of “stuff.” That same store began selling groceries five years ago or so and is now a small grocery store with a much larger selection than a 7-Eleven, smaller than a conventional grocery store or supermarket.

The industry has boomed due to the recession, reduced incomes and the cutoff of credit to millions of households. A family that did a once-a-month trip to Wal-Mart to stock up may now shop weekly at a dollar store. New customer populations, such as the aforementioned retirees, have found that dollar stores carry far more than discounted junk and at times have lower costs than Wal-Mart or the discount clubs.

The industry is taking share from traditional discounters such as Wal-Mart and K-Mart (owned by that dog of dogs, Sears (SHLD) ). Next year the industry plans to open 2,500 new stores; Wal-Mart plans to open 50 new concept, small-footprint stores to compete for this new kind of customer. Fifty stores against 2,500 is like bringing a knife to a gunfight.

As store volumes increase, so do margins, unlike Wal-Mart. Wal-Mart’s margins have been falling as it reduces prices to maintain market share and its typical cost of goods is already the lowest among all retailers. The dollar stores have close to these costs on many items but are not there yet so as volume increases their unit costs decrease.

The cost of opening a new dollar store is very low. New stores are typically in strip malls devastated by the recession and where landlords are desperate for a new tenant. This gives the dollar stores a cost advantage on overhead.

Investing in dollar stores 

That is the industry. Is there one name I like? While all three national chains are in good shape, I think investors should look at Dollar General before the others. Here is why.

  • Dollar General is the big boy on the deep-discounter campus. The company has 9,500 locations in 35 states.
  • DG’s quarterly sales are up in double digits, profits up more than 20% in the past year.
  • DG’s operating profit is what I and most others like to see in a retailer and it is up 16% this year. This is the profit that is the fuel for internally funded growth. While overall profit margins, as a percentage of sales, decreased due to an increase in grocery sales, the actual percentage of revenues allocated to overhead declined by one half of a percentage point, a sign of terrific management.
  • Dollar General is using this operating profit to build for the future. In 2011 it remodeled or re-located 575 stores and opened 625 new ones and it has  committed to opening at least 7% new floor space in 2012.

 

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That last item is a big number. While the economy appears to be mending, things are set to begin going south again for many in the second half of the year and certainly in 2013, especially for people at the lower end of the income chain; more on that in a later column. And the softer the economy, the better it will be for the New American Grocery Store.

 

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