Do You Shop At Americas Favorite Dollar Store?

By Markets Fool.com

Continue Reading Below

One deep discount chain has proved to be much more of a customer favorite than the others.

It wasn't exactly a bait-and-switch scenario when Dollar Tree said it might have to close more stores than it previously estimated to satisfy antitrust concerns with its acquisition of Family Dollar . However, after the two deep discount chains had used a very low number of store closures to help sell the merger last month, some investors might still be annoyed by the new, higher figure. And with potential changes affecting consumers, customers at America's favorite dollar store might wind up annoyed, too.

Chopping down trees
Earlier this month, Dollar Tree said it was now looking at divesting upwards of 500 stores or so -- much higher than the initial estimate of 300 stores or less -- to meet FTC objections over its acquisition of Family Dollar. While the final number may still come in below 300, investors should also be prepared for more.

Of course, even if the store closings do climb to the upper end of that range, it remains far, far below the 4,000 or so stores Dollar General would have had to close had it been successful in winning the acquisition battle.

Because Dollar General and Family Dollar both sell products for $1 or more, they're much more closely aligned than Dollar Tree, which prices virtually everything at a dollar or less. Since there is a significant overlap between Dollar General and Family Dollar, the regulatory agency was concerned about what a merger of the two would do for pricing.

Continue Reading Below

Much ado about nothing
While I maintained during the bidding process antitrust concerns were overblown -- we're talking dollar stores here -- I still thought Dollar Tree's acquisition of its rival was a bad idea, because bringing the troubled deep discounter into its fold would significantly alter Dollar Tree's business model, one that has made it the industry leader despite being the smallest of the big three chains.

That leadership position was recently underscored by a survey released by the American Customer Satisfaction Index, an annual report gauging the opinions of 70,000 consumers across the country on how they view their shopping experiences at retailers across a broad spectrum of considerations, including the following:

  • Convenience of stores and hours
  • Frequency of sales and promotions
  • Variety and selection of merchandise
  • Layout and cleanliness of stores
  • Ability to provide brand names

In all, there are 10 different categories and on average the deep discounters ranked at a 77 out of 100. But breaking into the ranks this year, Dollar Tree handily outscored the industry and its rivals by chalking up a 79 rating while Dollar General and Family Dollar scored a below average 75.

That's not insignificant because ASCI finds there's a correlation between companies with high levels of customer satisfaction relative to their competitors tending to have higher earnings and stock returns.

Penny for your thoughts
There might be something to that. Dollar Tree, as the low-cost industry leader, has been able to translate that into superior operating margins compared to its rivals. For every one dollar in sales it makes, Dollar Tree turns more than $0.10 into operating profit. In comparison, Dollar General pockets $0.08 in operating profit from every dollar of revenue and Family Dollar makes less than $0.03 on the dollar.

It's more than just pennies from heaven for Dollar Tree, whose value proposition has made it the profitable leader among dollar store chains. Data: Morningstar.

This disparity raises concerns about what will happen next year after Dollar Tree absorbs Family Dollar into its fold.

Where Dollar Tree operated a few hundred Deal$ stores that sold merchandise at price points higher than a dollar, the vast bulk of its operations were its namesake stores where it held the line at a buck. Now it's bringing in 8,000 Family Dollar stores that tips the balance of its business away from that very successful business model.

Sales per square foot at Dollar Tree ran $187 last year whereasFamily Dollar generated $165 in sales per square foot. That will be the challenge it faces, boosting productivity of the one concept while not impairing the value of the other.

What it means for investors
Dollar Tree has been a consumer favorite because it was able to add refrigerated and frozen consumables at a bargain price as well as stock name brand merchandise on its shelves. But now it has gone and fundamentally altered that relationship. Although it becomes a big rival to Dollar General, adding Family Dollar doesn't necessarily make it a better one.

Investors would be wise to tread carefully in acquiring shares of Dollar Tree, which has gained more than 50% in value over the past year. Not only could it lose its preeminent position in the marketplace, but the deep discount retailer may have hurt itself where it counts most: its reputation with consumers.

The article Do You Shop At Americas Favorite Dollar Store? originally appeared on Fool.com.

Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.