With gas prices and unemployment high, low-income shoppers are not the only ones trying to find the best bargains in discount stores. Some of the largest stock-picking hedge funds jumped into Dollar General Corp, Family Dollar Stores Inc and Big Lots Inc during the first quarter as a string of reports suggested low-priced retailers were ripe for take-over deals.
And though the M&A news has been mixed at best, the group got another jolt on May 25 when Pershing Square's Bill Ackman said he was buying shares of Family Dollar. "It's a business that continues to take share even in recessionary environments," Ackman told the Ira Sohn Investment Conference in New York. "We think it's quite an attractive LBO," he added later in his speech.
Even without the potential for take-overs, expectations are high that discount retailers, particularly the so-called dollar stores, will keep winning over low-income shoppers.
"They're just in the sweet spot right now," said Wells Fargo analyst Matt Nemer. "Their prices are really very, very low and they have convenient locations that you don't have to spend a lot of gas to get to." Funds including James Dinan's York Capital Management, Steve Mandel's Lone Pine Capital and Eric Mindich's Eton Park Capital Management bought into or increased their positions in one or more of the chains in the first quarter, according to Thomson Reuters data.
Dollar General and Family Dollar sell everything from milk to clothing in thousands of small stores. Wal-Mart Stores Inc and others may offer better prices, but their stores can be hard to reach and their larger packages cost too much for those on tight budgets, especially as paychecks run low.
"To the extent that customers are living paycheck to paycheck ... it's nice to be able to buy one bar of soap," said Nemer. Though rising wholesale prices have squeezed retailers, dollar stores can win as inflation hits food, clothing and other goods. Shoppers looking for low prices visit more often, leading to higher overall sales, and many of them switch to less expensive private label goods, which have higher margins. Analysts largely prefer Dollar General. Nemer likes that it can continue to pay down debt, which locks in some earnings growth.
Richard Chilton's Chilton Investment and Alan Fournier's Pennant Capital opened new positions in Dollar General in the first quarter, while Mandel's Lone Pine Capital and Thomas Steyer's Farallon Capital raised existing stakes. Lee Ainslie's Maverick Capital was the only member of the Smart Money 30, a group of some of the largest stock-picking hedge funds, to cut back on the stock.
Majority-owned by private equity firm Kohlberg Kravis Roberts & Co LP, Dollar General is also further along than competitors in improving its line-up of private label and discretionary items.
Most people see private label items as comparable to branded goods, said Avondale Partners analyst Mark Montagna.
Wal-Mart and Target Corp are trying out smaller stores, but Dollar General and Family Dollar already know how to run such shops, and they keep opening more. Dollar General has about 9,500 stores in 35 US states, more stores than any other US retailer. It plans to enter four more states, including California, sometime next year.
Chairman and CEO Rick Dreiling said he sees opportunities for 12,000 more Dollar General stores across the country.
Those who prefer Family Dollar like the room it has to improve, in part because selling more of its own branded goods will help increase its margins.