Dollar Tree (DLTR) will buy rival Family Dollar (FDO) for $8.5 billion, the companies said Monday … and if this doesn’t prop up once high-flying DLTR stock and the other dollar stores, it might be time to forget about deep discounters as an investment.
It was all part of the so-called hourglass theory of retail, where high-end and low-end stores benefit at the expense of those in the middle.
The hourglass idea – which is popular during recessions and recoveries — is that although wealthy people can keep up (most) of their spending, everyone else has to trade down. Dollar stores, which are at the bottom of the hourglass, find themselves flush with new customers like cash-strapped middle-income shoppers.
The hourglass theory worked for a couple of years, but then it fell apart.
A surge in traffic and bullish market sentiment sent DLTR and FDO stock — as well as shares in Dollar General (DG) — on a tear. A little more than three years after the bear-market bottom of March 2009, DLTR stock was up as much as 262%. FDO stock doubled, and DG stock added 135%. (The broader market was up about 75% over the same span.)
What the hourglass theory didn’t account for was the behavior of lower-income shoppers. With no place to trade down to, they have no choice but to buy less. As we’ve noted before, for companies like Walmart (WMT) and McDonald’s (MCD), in many ways the recession never really ended. Too many of their customers are living too close to the bone to part with what limited discretionary dollars they have.
FDO, DG, DLTR Go From Leaders to Laggards
It took a little while, but the same economic forces of low wages and job instability caught up to the dollar stores — just as they were rolling out new locations and cutting prices to remain competitive. That has DLTR, FDO and DG stock seriously underperforming the market the last couple of years.
Indeed, for the year-to-date, the S&P 500 is up 8%, but the dollar store stocks are all negative. DLTR stock was off 3% heading into Monday. DG was down 7%. And FDO stock had lost almost 8% on the year before the DLTR deal.
DLTR is paying a 23% premium for FDO stock in the transaction — comprised of cash, DLTR stock and the assumption of debt for a total value of $9.2 billion — and it ends years of speculation over what would become of FDO.
With activist investors Nelson Peltz and Carl Icahn pressuring FDO to sell, well … it was only a matter of time before it did.
Consolidation is always good for stock in the affected industry, so anyone holding dollar-store stocks stands to benefit.
But it gets better.
As we’ve seen with other proposed mergers and acquisitions in this frenzied year of dealmaking, the competition isn’t likely to stand pat.
Don’t be surprised if Dollar General swoops in with an even bigger payday for FDO stock.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.