If The Economy Is Improving, Why Are Dollar Stores The Only Retailers With Positive Trends?

The retail sector per se is in the doldrums, fighting more than one foe - fundamental flaws, a behemoth that is steam rolling over their prospects and a see-sawing economy.

The retail sector has been bleeding jobs for four straight months now. Earnings reports of retailers are speaking volumes about the struggles the sector is going through.

Online Challenge

Amazon.com, Inc. AMZN has pushed retailers to the brink, with its business model that has made buying online attractive rather than at physical stores. The convenience offered by online purchase with respect to shopping and payment and the choice alternatives have made it the preferred mode of buying for consumers.

Bucking The Downtrend

Even as the retail onslaught continued amid the changing landscape, one class of retailers has emerged unscathed or with minimal damage. Discount retailers or dollar stores, typically weather an economic downturn much better than the other retailers. The reason being in trying times, people begin to patronize those stores that offer more for less dollars — precisely the concept behind dollar stores.

These stores are capable of making available products at cheaper prices due to economies of scale. Taking stock price as a proxy for performance, Benzinga looked at how dollar stores such as Ollie's Bargain Outlet Holdings Inc OLLI, Casey's General Stores Inc CASY, Dollar General Corp. DG and Five Below Inc FIVE fared relative to other retailers, which offer full-priced products.

OLLI Source: Y Charts

As can be seen by the stock performance, some of these discount retailers such as Ollie's and Five Below have generated stock returns in excess of 42 percent and 20 percent, respectively in the year-to-date period. Even the ones that generated negative returns had not fared as worse as their full-priced shop counterparts. Dollar General has been down 3.60 percent and Casey's has lost 10.2 percent.

This compares to solid double-digit percentage losses for Kohl's Corporation KSS, Dillard's, Inc. DDS, Macy's Inc M, Sears Holdings Corp SHLD and Target Corporation TGT. Wal-Mart Stores Inc WMT, meanwhile, has managed to record gains in excess of 9 percent for the year-to-date period.

The showing of discount retailers has come, however, amid an improving economic backdrop, when historically they fare badly, as affordability pushes consumers to ditch cheap ones in favor of good quality expensive items.

Economic Backdrop

The U.S. economy is chugging along at a fairly decent pace. In the first quarter of 2017, the U.S. GDP expanded 1.2 percent quarter-over-quarter, although representing a slowdown from the 2.1 percent rate in the fourth quarter of 2016 and the 3.5 percent pace in the third quarter of 2016. Since emerging from the Great Recession in the third quarter of 2009, quarterly growth has averaged 2.1 percent.

The job market is also alive and kicking, with the average job gains thus far this year at 162,000, and the jobless rate is trending closer to cycle lows. The average hourly earnings was up $0.03 in May, suggesting marginal increase in wages.

Source: BLS

The average credit score nationwide hit 700 in April, up one point from last fall, a Fox News article, quoting new data from Fair Isaac Corp. said. This marked the highest since at least 2005, the year when the Fair Isaac began tracking the data. Higher credit scores would mean banks will be less circumspect while lending, making the terms of credit easy.

Consumer confidence is also trending closer to record highs. That said, consumers still remain price sensitive. The recovery, though steady, has been anemic. Added to this, the global macroeconomic environment and geopolitical situation have introduced caution among investors. Domestically, there has been increasing uncertainty concerning policy measures pursued by the new Republican administration under President Donald Trump.

How Discount Retailers Survive Amazon Onslaught

Dollar General's approach to "cheap crap" retail segment is playing out perfectly, according to Daily Reckoning. The company's minimalist approach is paying off, as it has stuck with the policy of not bogging down the balance sheet with massive stores and tons of staff.

Giving reasons as to how discount retailers can stay afloat, Seeking Alpha contributor Rohit Chhatwal said they have an edge over Amazon due to their proximity to customers and the lower average transaction size in the store.

The small size of stores is also helping these companies, as acquiring smaller retail space is easier.

"As these stores get a better footprint across the urban centers they will be in a much better position to meet the challenges of Amazon and give better returns to long-term investors than their bigger counterparts like WMT and TGT," Chhatwal said.

Analysts Upbeat On Discounters

Following Casey's fourth quarter earnings miss, Deutsche Bank said it expects EBITDA growth to pick-up later in the fiscal year 2018, once modest grocery inflation returns and as the company cycles the increase in store manage salaries.

Meanwhile, reviewing Ollie's better-than-expected first quarter results released in late May, Jefferies said it expects the company to benefit from secular tailwinds.

The firm said it likes Ollie, longer term, as it believes as a closeout retailer, it would benefit from excess inventory in an oversold America.

"OLLI remains an appealing high unit growth story with good new store productivity and an ability to leverage at a relatively low comp in the 1–1.5 percent range," Jefferies said.

"It is investing excess margin in a stronger value proposition to perpetuate share gains."

Meanwhile, Piper Jaffray said Ollie's business model of selling "national name brands at a discount" remains very relevant with consumers, as evidenced by a 29 percent increase in its Army membership to 7.9 million members in the first quarter.

"Additionally, amidst a tough brick and mortar retail environment, OLLI is seeing excellent buying opportunities, allowing for better product offerings at attractive margins," Piper Jaffray said.

The outperformance by discount retailers could continue through the rest of the year, as their recent solid showing have come despite economic conditions remaining vibrant enough to support retail spending. Amazon, the common enemy of brick-and-mortar stores, could also be countered by these stores, which capitalize on small store size and value proposition they offer.

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