Looks like Wal-Mart is finally coming after Dollar General -- and it seems to be working.
Shares of America's two largest dollar store chains tumbled Thursday after both reported quarterly sales that fell short of Wall Street estimates. One, Dollar Tree, also cut its sales forecast for the year. Both companies mentioned increased competition and deflation. Dollar General suffered from that sadly common retailer affliction, "unseasonably mild spring weather."
But the real problem for both was Walmart.
The gargantuan retailer, which once ruled the discount space, tried unsuccessfully for years to stave off the dollar stores with its own version, called Walmart Express. It abandoned the idea earlier this year, selling off many of its 100 Express stores to Dollar General.
But now it's trying a new strategy that better plays to its strengths: Using its hefty $10 billion in free cash flow year to date to cut prices on key traffic-driving items such as laundry detergent and fresh fruit in the locations closest to dollar stores. Since June, Walmart has cut prices at 800 stores in markets such as North Carolina and Illinois, according to Supermarket News.
Wolfe Research analyst Scott Mushkin has been keeping tabs on what Walmart has been doing in North Carolina as a proxy for the price cuts it could unleash across the country. A basket of fast-turning and popular items such as peanut butter and apples were 12.6 percent cheaper at some North Carolina Walmarts this month than a comparable basket of goods in nearby Dollar General stores, according to Mushkin's analysis. He found the prices in North Carolina Walmarts were 6.5 percent lower than prices in other cities where Walmart operates.
Let's pause to consider that for a moment: How can a store chain with the name "dollar" in it have higher prices than Walmart?
Walmart has not outlined details of its pricing plan. But Mushkin suggests Dollar General would be hit hard if Walmart were to replicate the price moves he's tracked in North Carolina in all 4,600 U.S. stores. Eighty percent of Dollar General's stores directly compete with Walmart for business, he estimates.
Walmart's not the only one cutting into the dollar stores' wallets. German no-frills supermarket Aldi has also been expanding in the U.S. at a faster clip. And with its other German competitor, Lidl, poised to enter the U.S., the race to the bottom is unlikely to abate.
Cutting prices to the bone -- worsening the deflation that has gripped America's mass merchants lately -- doesn't tend to be a winning long-term strategy. It especially hurts retailers that aren't opening new stores, which lets chains make up the difference on volume, at least in the short term.
Still, unless dollar stores remain true to their name and start cutting prices to compete with Walmart's, the lower-income shoppers on which they depend will defect.
Don't forget that investors, too, like bargains. Before Thursday, shares of Dollar Tree had soared 27 percent and 23 percent, respectively, so far this year. Thursday's selloff has only taken their valuations back in line with historical and industry averages. Their peanut butter might not be the only thing that needs to get cheaper.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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