Wal-Mart Stores, Inc. (NYSE:WMT) is perhaps the most feared retailer in the United States. Its presence in small and large markets alike can send smaller retailers into bankruptcy overnight. Although Wal-Mart has a large share of low-income shoppers, it has historically missed out on the stingiest of this crowd — a group that regularly forgoes the big box retailer in favor of dollar stores. As a result, Wal-Mart Stores, Inc. (NYSE:WMT) has begun an effort to attract these customers through its Neighborhood Market format, which will compete with Family Dollar Stores, Inc. (NYSE:FDO), Dollar Tree, Inc. (NASDAQ:DLTR), and other dollar stores.
Although Wal-Mart is much larger than its dollar store competitors, gaining a significant share of the market will not be as easy as simply building the stores and waiting for customers to come. The dollar stores have earned outsized returns on capital for many years, and with good reason. The barriers to entry are substantial, which will not make for an easy entrance for Wal-Mart Stores, Inc. (NYSE:WMT).
For the most part, dollar stores have substantial room for growth in the U.S. Family Dollar and Dollar Tree, Inc. (NASDAQ:DLTR) have each grown EBITDA per share at a double-digit rate per annum over the last decade. Despite this impressive growth, there have been no major new entrants to take advantage of the favorable industry economics.
More importantly, Family Dollar and Dollar Tree, Inc. (NASDAQ:DLTR) also continued earning stable profits during the Great Recession due to lower consumer buying power. This is what caught the attention of Wal-Mart in the first place; the poorest of Wal-Mart Stores, Inc. (NYSE:WMT)’s customers fled to the even lower-priced dollar stores. This is a tremendous advantage that will prop up dollar stores’ bottom lines should the United States enter a protracted period of sluggish growth.
Wal-Mart has been trying to enter the dollar store market since 1998 and has yet to make a serious market share grab. Its Neighborhood Market stores have struggled to maintain profitability since the program began fifteen years ago and the traditional dollar stores’ margins have been unimpaired by Wal-Mart Stores, Inc. (NYSE:WMT)’s sluggish entrance into the space.
A large part of the problem is that Wal-Mart is not copying the format that has worked so well for Family Dollar Stores, Inc. (NYSE:FDO) and Dollar Tree, Inc. (NASDAQ:DLTR). Instead, its Neighborhood Market format is much larger than the typical dollar store and carries the same type of merchandise as its Wal-Mart Stores, Inc. (NYSE:WMT) Supercenters. The stores are bigger for a reason; instead of stocking one or a few different products in each product type, Neighborhood Markets stock a wide array of products. For instance, the stores carry a much larger selection of peanut butter than other dollar stores. This is a problem because dollar stores rely on high inventory turnover to earn a profit, which is harder to do when a store carries a deep selection of products.
Even if Wal-Mart were to change its dollar format to mimic that of Family Dollar Stores, Inc. (NYSE:FDO) and Dollar Tree, Inc. (NASDAQ:DLTR), the company is so far behind in store count that it would have to acquire a large chain in order to become a serious competitor any time soon. Wal-Mart had a notoriously difficult time entering the Japanese market because it did not adapt its stores to the culture; the company appears to be making the same mistake with its dollar store format.
Since Wal-Mart Stores, Inc. (NYSE:WMT) does not represent a viable long-term threat, Family Dollar and Dollar Tree, Inc. (NASDAQ:DLTR) may represent good investments. Family Dollar trades at 17.5 times earnings and Dollar Tree at 18.5 times earnings. Both companies’ history of double-digit per-share EBITDA growth, in addition to their solid grip on the dollar store segment, makes these multiples appealing for long-term investors.
The article Can Wal-Mart Topple the Dollar Stores? originally appeared on Fool.com and is written by Ted Cooper.
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