When $1 can be much more: The dollar-store divide

Cash-strapped consumers are finally catching a break — and one group of retailers is positioned to capture the windfall.

Thanks to a round of minimum wage hikes and a lower unemployment rate, dollar stores are poised to benefit from a healthier low-income consumer. But in analysts' eyes, there's one chain in particular that's likely to reap the biggest reward.

A one-dollar price tag appears on a greeting card at a Dollar General store.
Emile Wamsteker | Bloomberg | Getty Images

Under the leadership of a new management team, Dollar General's fiscal fourth-quarter comparable sales beat expectations for the first time in 2 ½ years. The retailer also topped Wall Street's consensus estimate of $1.26 a share, instead reporting earnings of $1.30. Meanwhile, the company outlined plans to add 900 new stores in 2016, including an expansion into urban markets.

But while analysts responded favorably to Dollar General's recent performance and plans, they were far less enthusiastic about the results at Dollar Tree. Less than one year after its acquisition of Family Dollar, Dollar Tree's latest quarterly earnings results fell 6 cents short of Wall Street estimates.

Notably, same-store sales at its flagship Dollar Tree division slowed during the quarter, causing analysts to question whether the integration is causing the company to lose focus on its core business.

This split in sentiment is reflected in the companies' stock movements. Though both names are trading near $80 a share, Dollar General shares have risen 17 percent year to date; meanwhile, Dollar Tree stock is up just 4 percent over that time.

"It's been a difficult integration," Ken Perkins, president of Retail Metrics, told CNBC. "It was a major acquisition and there are a lot of balls in the air."

A 'Herculean' task

Though early results from Dollar Tree's purchase of Family Dollar have been somewhat shaky, purchasing its higher-price competitor was a quick way for the company to close the gap with the behemoth Dollar General.

At the end of 2014, Dollar General's nearly 12,000 store footprint was more than double the size of Dollar Tree's; after the acquisition, however, Dollar Tree is now in the lead, with close to 14,000 locations. Purchasing Family Dollar likewise delivered a big boost to Dollar Tree's top-line, driving its annual revenue from $8.6 billion in 2014 to $15.5 billion last year. Dollar General's 2015 sales were $20.4 billion.

"They [Dollar Tree] had the smallest footprint of all the dollar stores and they needed to make a bold move," Perkins said. "For them to try to grow their business [to that size] organically … would have required a Herculean effort."

But while the purchase of Family Dollar lifted Dollar Tree's top-line, it also added operational woes. After visits to Family Dollar stores earlier this year, BB&T analyst Anthony Chukumba said the locations appeared cluttered and dirty, and there were several instances where merchandise was out of stock. However, he noted that these stores have made progress in increasing the amount of products that have a $1 price tag (Family Dollar stores do not sell everything for $1 or less; Dollar Tree stores do).

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Perkins cautioned that because the acquisition was so recent, it's too early to draw conclusions as to its success. During the company's earnings release, management reiterated it is on schedule with realizing the synergies from the deal, which it has pegged at $300 million annually by the end of the third year.

Opportunities include rebranding stores in certain locations from Family Dollar to Dollar Tree, to better cater to a certain region's population. And despite falling short of Wall Street forecasts, both the Dollar Tree and Family Dollar segments experienced higher traffic. Still, Chukumba remains cautious.

"We believe Dollar Tree's worse-than-expected fourth-quarter results and 2016 guidance demonstrate the Family Dollar integration will be much 'easier said than done,'" he said.

While Dollar Tree is busy sorting through its issues, Dollar General is mapping out expansion plans. The most notable shift in the company's strategy is its decision to open smaller stores in more urban markets, with plans for 80 of these locations this year.

"We see a long runway to growth with potential for nearly 20,000 Dollar General stores over time," Stifel Nicolaus analyst Taylor LaBarr said.

The reinvention of the dollar store

As an overall industry, dollar stores have been ratcheting up growth in both sales and square footage for the past several years. According to retail research firm Conlumino, nearly 6,000 of these stores were opened across the U.S. from the end of 2010 through 2015, for a total of 29,852 locations. Over that same period, Conlumino said the category's sales shot up from $30.4 billion to $45.3 billion. That nearly 50 percent growth rate easily outpaces the 17 percent increase in overall retail sales from 2010 to 2015.

Neil Saunders, managing director at Conlumino, attributed part of the segment's growth to the stores' evolution.

"A typical dollar store today looks very different to one 10 years ago," Saunders said. "It's lighter, it's brighter, it's more shoppable."

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This evolution, along with the recession-born tendency to be frugal at any income bracket, have helped these stores attract a more well-heeled shopper. What's more, Saunders said their rapid square-footage growth has allowed them to become a convenience play, much like a corner drugstore.

But while these trends will continue to give dollar stores a lift, the segment also faces headwinds. Though Saunders predicts the growth of dollar stores will continue to outpace the overall retail market, these shops have begun to reach penetration in certain markets. As such, they will need to rely more heavily on having a broad array of products.

Dollar stores also face increasing competition from drugstores and new rivals such as Five Below, where everything costs $5 or less. And although Wal-Mart's decision to abandon its small-format Express stores will be beneficial for dollar stores in the long term, it is not expected to provide an immediate boost. That's because Wal-Mart only opened roughly 100 of these stores since piloting the format in 2011.

"Obviously the exit helps because it's one less competitor in the neighborhood," Perkins said. "It also speaks to how hard it is to run that business."