I’ll confess I’m surprised to see it happening. But, numbers don’t lie. Bargain-oriented retailers — the so-called “dollar stores” — have resisted giving up ground in the wake of the economic rebound, even though it was an opposite economic implosion that ushered the likes of Dollar Tree (NASDAQ:DLTR), Dollar General (NYSE:DG), and Family Dollar Stores (NYSE:FDO) into their current state of greatness.
While their valuations and technicals might say these stocks are a little frothy, their long-term bullish case holds up pretty well.
Proof of the Pudding
While the growing sub-culture of frugal consumerism has been anything but a secret since 2008’s economic Armageddon, it really wasn’t until last year that investors were forced to wake up and smell the discounted coffee. That’s when shareholders of 99 Cents Only Stores — back when it still was a publicly traded company — became the beneficiaries of a private equity deal that was generous at the time, but in retrospect, perhaps was not generous enough.
It was a move that surprised investors, not to mention some Wall Street analysts, who cited the rich premium being paid. Yet, when you take a good look under the hood of all of these companies, it’s not surprising that one of them was acquired. What’s surprising is that more of them haven’t been acquired yet, given the earnings trend they’re all logging.
It can be tough to get a good feel for growth with raw numbers alone, but when you’re seeing the trend with your own eyes, it’s pretty much impossible to deny.
I make that point first to set up a look at the almost-disturbingly reliable growth from the remaining dollar stores. All three charts of the industry’s big names are nearby, but there’s really only one story to tell — these retailers are growing the top and bottom line no matter what curveballs the economy throws at them, and no matter how consumers’ moods change.
In all three cases:
- With only one exception, we’ve seen three years of year-over-year quarterly earnings increases.
- In the past 48 quarters the three companies have collectively logged, we’ve seen 18 earnings beats and not a single miss.
- The average earnings growth for the past year rolls in at a solid 17.7%, and the annual growth rate forecast for the next three to five years is an average of 36%.
I dare you to find another industry that’s done as well, and done so as reliably.
On the Other Hand, Timing Still Is Everything
There’s a flip side to every coin, and the deep-discounters are no exception. The potential nagging downside here is what some would consider a frothy valuation.
See, it took the market about three nanoseconds to bid these three names up to frothy P/E levels once the 99 Cents Only deal was put on the table. Makes sense — where there’s smoke, there’s fire. Funny thing about those “obvious” M&A targets, though … investors predict a lot more of them than actually pan out.
Perhaps potential suitors are eying the typical trailing P/E of 21.7 here, and deciding the premium they’d have to pay is too high. After all, the 99 Cents Only deal went down at a 32% premium to the pre-deal price, yet that price was only 20.4 times trailing earnings. I doubt it’s a coincidence that’s where the remaining three dollar stores are trading now, but that’s a little rich for potential buyers.
As all three charts illustrate, though, those P/E ratios are at those high-ish levels mostly because of their very recent gains. While deserved on a fundamental basis, those valuations might be tough to hang onto on a technical basis.
So Now What?
Yep, it’s a conundrum — the business model clearly is a winner in today’s cost-conscious world, yet the price you’d have to pay right now feels more than a little uncomfortable. Your concern isn’t unmerited.
Here’s the solution: Wait.
The most recent three months of these long-term rallies were excessively bullish predominantly because rumors of more M&A within the industry have resurfaced. Ironically, the rumors that drove those stock prices higher are exactly why deals aren’t apt to happen now. Once these speculators get bored with waiting and realize these names aren’t getting bought out at those lofty levels (there’s no room left for a premium), they’ll start shedding them, sending them back to more palatable P/E levels. That’s somewhere between 11 and 15, or even as high as 16 if you’re feeling generous.
They’re worth the wait.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
