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Conventional Wisdom Wrong: Dollar Stores Aren't Recession Proof

What a difference a year makes.

In September 2004, Dollar General Corp.'s prospects looked promising, with monthly sales up 4.2 percent from the same period in 2003. But high fuel prices, which are taking a bite out of consumers' pockets and also increasing retailers' delivery costs, may mean only 1 to 2 percent growth this September for Dollar General, according to estimates from CIBC World Markets analysts.

An almost 50 percent increase in gas prices since September 2004 is hurting every retailer, but dollar stores appear to be faring the worst. A full 72 percent of lower-end customers are cutting back their retail budgets because of higher prices at the pump. That's higher than the average for all customers, which is about 67 percent, says Nick McCoy, a senior consultant with Retail Forward. "There's no question that the core dollar store shopper is probably being hit hardest by fuel costs."

Rising interest rates are also cutting into disposable income.

Discount dollar industry same-store sales increased just 0.4 percent in the first half of this year, in contrast with a 4.1 percent rise two years ago, according to Patrick McKeever, an analyst with Sun Trust Robinson Humphrey.

"We continue to see our core customer's discretionary spending being pressured by higher gas prices and unemployment," says David Purdue, Dollar General chairman and CEO. "Customer debt continues to rise and as interest rates rise, this may become an even greater burden. All of these factors put pressure on our sales."

Lower traffic counts and sales figures are poking holes in once-popular theories that dollar stores were recession-proof. The industry has trumpeted this line as it has raced to open thousands of new stores. The industry's two biggest chains, Dollar General and Family Dollar, will add 730 and 500 stores this year to their store bases of 7,200 and 5,600, respectively. Dollar store backers have argued that even if lower-end consumers had to cut back, higher-end consumers would continue to shop at discount stores to save a buck. While there may be some truth to that, for now Wal-Mart appears to have been more successful at attracting higher-end customers being squeezed by rising fuel costs.

"We see continuing evidence of Wal-Mart growing comp sales faster than the dollar stores in the last few months," says Dan Wewer, an analyst at CIBC World Markets. "The gap may be attributed to a more promotional Wal-Mart, coupled with customers bundling their purchases into fewer shopping trips made to destination stores such as Wal-Mart, rather than fill-in locations like the dollar stores."

Thursday, Wal-Mart is expected to announce 3.8 percent same-store sales growth for September, compared with 2.3 percent last year.

In a move to prop up falling share prices, both Family Dollar and Dollar General said this week they would buy back about 10 million shares each. Already this year, Dollar General has repurchased about 8.4 million shares. While that may temporarily help share prices, the dollar store sector still needs to somehow compensate for a drop in shoppers and rising freight costs.

Family Dollar Stores Inc. reported a 15.7 percent drop in net income to $217.5 million for its fiscal fourth quarter ended Aug. 27. Same-store sales increased just 0.6 percent from a year earlier -- the company's weakest quarterly performance in more than five years, says McKeever. Both Family Dollar and Dollar General will release September sales Thursday.

Traffic at Dollar General fell 2.1 percent in August from the previous month, while Family Dollar experienced a 2.3 percent decline in traffic during its fourth quarter. To increase traffic, Dollar General said it would step up plans to add more coolers to stores. Perishable items are experiencing the fastest sales growth, said the company in its 2005 second quarter conference call.--David Koch

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