Dollar Stores May Have Happy Holidays

For the last two months, retail sales declined as the combination of the financial crisis, further deterioration of the housing market, and increased unemployment has resulted in consumers literally spending only on current needs, such as low-priced basics and consumables and only when they need them. Sales of discretionary products, whether home furnishings, apparel, consumer electronics, sporting goods, jewelry, or luxury goods, have virtually fallen off a cliff.

Nevertheless, Christmas will come as it always does, but we expect gift giving to take on a theme of "frugality" and "practicality" marked by very price conscious purchasing decisions. The concept of "trade down" is evidenced by the relatively better performance, as measured by traffic and comps, at discounters, warehouse clubs, dollar stores, and grocery stores.

This behavior should also result in more customer traffic in power centers near the discounters and less traffic at the malls. Retailers have had to respond quickly and are promoting Black Friday much earlier this year ([ Sears Holdings (ticker: SHLD) unit] K-Mart and Wal-Mart Stores (WMT) are just two examples) in order to drive traffic and are very much emphasizing value.

Experts are predicting that the following themes will dominate Christmas shopping: necessities rather than luxuries, practical apparel and household goods, and at-home entertainment categories such as DVDs, video games, and books. Other categories of retailers are likely to be under pressure, including department stores and category killers selling consumer electronics, home improvement, toys, and office supplies, as customers shift their spending to more value-oriented retailers such as mass merchants and other discounters.

Below, we have compiled a wide range of holiday forecasts which range from very optimistic, up 4.7% by Nielsen, to very negative, down 5.0% by Brand Keys, compared to a 2.4% gain last year. We are inclined to forecast that retail sales will be flat to slightly down this season. In this note, we examine the macroeconomic headwinds that consumers are facing as well as the calendar shift.

Out of our entire [hardlines retail] universe, we remain favorable on the dollar-store group [ Big Lots (BIG), Dollar Tree (DLTR), Fred's (FRED) and 99 Cents Only Stores (NDN)] despite their relatively better stock-price performance and higher multiples as we expect consumers to continue to buy basics and consumables and to trade down to value-oriented retailers like the dollar stores.

In addition, there are company-specific top-line and bottom-line driving initiatives that are working and should help offset higher operating costs, such as labor and utilities.