What’s next for ... Dollar Tree Inc.?

Discount retailer expands, believing that shopping habits formed during the recession will continue in better times

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Print this page by Tim Loughran

No matter what the economy is like, people still need to buy toilet paper.  Chesapeake-based Dollar Tree Inc. thrived in a lousy economy as consumers flocked to the company’s discount stores, looking for bargains on household goods. As unemployment falls and consumer spending rises, Dollar Tree is betting that it will remain just as profitable.

In 2010, the nation’s third-largest dollar-discount retailer saw annual sales, profits and operating margins continue to rise even after it built 235 stores, opened a new distribution center in California and purchased an 86-store chain in Canada —  an acquisition that it plans to expand 20 percent by the end of this year.

“Dollar Tree had another terrific year in 2010, and we’re off to a great start in 2011,” CEO Bob Sasser said earlier this year. “Our mix of basic, consumable products, things you need every day, and high-value seasonal and discretionary product, all at $1, continues to thrill our customers.”

Or as BB&T analyst Anthony Chukumba put it during an interview with Bloomberg Businessweek: “Conspicuous consumption is out and saving money and value is in.”

Dollar Tree saw its sales jump by more than 12 percent for the second straight year, to $5.88 billion. Same-store sales (which exclude figures from new stores) rose 6.3 percent. Operating margins surged to 11.2 percent (the highest since 2000), up from 10 percent a year earlier, and net income surged by 24 percent to $397 million. 

In fact, the continued prosperity of the entire dollar-store retail segment — based on increasing evidence that it’s drawing more and more customers who traditionally shopped at Wal-Mart and Target for their household incidentals — has attracted offers from private equity firms in recent months. Matthews, N.C. -based Family Dollar, for example, rejected an unsolicited bid by Trian Fund Management LP hedge fund, while members of the Schiffer-Gold family, which founded 99-Cent Only Stores, teamed with Leonard Green & Partners LP in March in an offer to take the Commerce, Calif., chain private.  Speculation swirled in the business press that others, including Dollar Tree, might soon be targets. (Dollar Tree did not respond to a request for comment.)

To keep pace with larger rivals like Dollar General and Family Dollar, Dollar Tree plans to open 300 stores and expand 75 others in 2011. By increasing overall selling space by 7 percent and pushing store managers to boost same-store sales by 5 percent, Dollar Tree hopes to post $6.5 billion in revenue this year, a 10 percent increase from 2010.

Most of the company’s newest locations will be built in the Southeast, a region that along with Southern California and the Southwest is a main focus of Dollar Tree’s growth strategy. (Born in 1953 as a single K&K “five & dime” store in Norfolk, the company opened its first five Dollar Tree locations in 1986.) To serve these new stores, the company has budgeted $19 million in the next 12 to 24 months to increase the size of the company’s Savannah, Ga., distribution center from 600,000 to about 1 million square feet.

Another spending priority will be $10 million to replace aging cash registers and upgrade point-of-sale equipment at hundreds of Dollar Tree stores around the nation. At the same time, company officials said an undisclosed amount will be used to retrofit about 225 locations with freezers and refrigerated-food display cases.
According to Sasser, frozen food “drives traffic into our stores and provides incremental sales across all categories, including our higher-margin discretionary products. The plan is to continue to expand this category.”

Confident that low-income families always will shop at stores like Dollar Tree for household essentials, inexpensive toys, food products and holiday decorations, Sasser believes that more affluent, “trade-down” customers who added discount stores to their shopping trips during the recession will not abandon Dollar Tree once the economy improves. 

Others agree with his assessment. Motley Fool analyst Dan Caplinger wrote this spring that the “surprising thing is that as the recession fades into the past, Dollar Tree and its competitors are still doing well. Yet with unemployment still high, discount retailers still have a wide base of potential customers to serve.”
A potential speed bump for Dollar Tree could be inflation. Investors and industry analysts worry that Dollar Tree might have to abandon its guarantee to keep its prices below a dollar as the economy strengthens.

In a recent conversation with investors and Wall Street analysts, Sasser appeared to welcome that challenge. “History shows that Dollar Tree has consistently managed through inflationary and deflationary cycles by changing the product or changing the source,” he said.

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