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As the Economy Improves, Are These Stocks Doomed?

Saturday - 4/6/2013, 5:52pm  ET

Throughout the recent economy decline, one industry that thrived was that of specialty discount stores. Stores that offered products for only $1 brought people in for basic home goods, toiletries, and other retail items. As the economy is picking up, do these stores still have the same appeal to consumers and investors?

Five Below is a very unique type of specialty discount store. It offers 4,000 different products for teens and pre-teens, all priced between $1 and $5. As of March 2013, the company operated 244 stores across the country.

It announced fourth-quarter earnings at the end of March and beat analyst estimates, with earnings coming in at $0.39 per share. Sales were up 26% from the same period in the previous year. It was a monumental increase from the previous quarter of $0.03 in earnings per share. It opened 52 new stores last year that helped boost sales.

The company announced that first quarter sales for this year would be lower than previously anticipated. It expects earnings to come in at only $0.01. This is an improvement from the same time last year when the company lost $0.02 per share.

A second concern for the company is the rising cost of goods. Gross margins are only 31%, and will likely decline in the next few months. Also, capital expenditures for expanding brick and mortar stores are eating into profits. Analysts expected $0.70 per share in earnings next year, but the company announced it would be closer to $0.62.

Same-store sales increased about 4.4% last year. So, there is some organic growth with this company. But, it is valued at 60 times next year’s anticipated earnings. This is extremely overvalued. Investors should stay away from this stock for now.

Family Dollar Stores is a general discount retailer. It serves low and middle-income families in 45 states with over 7,400 stores. Family Dollar, like Five Below, announced an improvement in overall sales for last quarter. Family Dollar saw a 12% increase.

Family Dollar has also been expanding its brick and mortar stores. This has been helping top line growth. The company faces margin pressures as well. Its current gross margin is slightly better than Five Below, coming in at 34.66%. Another issue with these discount stores is price competition. The cost of goods are increasing, so stores must stay profitable and draw in more people. Price wars are dangerous for companies like Family Dollar.

It is announcing its next earnings report on April 10. Earnings are expected to be $1.22 per share. This is in line with the cyclical sales, and an increase of 6% from the same time last year. The company has failed to meet Wall Street expectations for the last three quarters as earnings have been declining.

The company is also facing a lawsuit from investors because they believe Family Dollar failed to disclose certain information about a decline in demand. With the pressure on margins, investor lawsuits, and its failure to meet earnings expectations, this stock doesn’t look too appealing. It has seen a few downgrades from Buy to Neutral and Neutral to Sell, as well.

A final company to mention is Dollar General . This company hasn’t had the same difficulties as Family Dollar and Five Below. The company grew its fourth-quarter sales 0.5%. The growth was much lower than the other two companies, but it grew by increasing market share.

Year over year, net income has grown 34%. Next year, the company expects a growth of 10-12%, even with margin pressures and price competition. It hasn’t focused only on building new stores, but also on renovating and improving its current stores.

It is currently valued at only 17 times next year’s earnings – much lower than Five Below’s 60 times valuation. Investors are expecting growth in the next year and a return on their investment. Dollar General stands out above Family Dollar and Five Below. Its one-year price target is $56.45 per share.

As the economy improves, at least one of the discount stores still look attractive. The one that focuses on steady, manageable growth, and the improvement of current stores is the one to invest in. 

This article was originally published as As the Economy Improves, Are These Stocks Doomed?on

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