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Cheap Americans Are Here to Stay

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Why Dollar Tree is poised to grow, even after the recession ends.

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When you see a Bentley parked outside of a 99 Cents Only store, as one Los Angeles resident did recently, it's pretty easy to see why it will be a long climb back for retailers.

At the high end and the low end of the scale, American consumers are struggling with high unemployment, lower home and stock prices, and historic debt levels. So it's not surprising that they want a dirt-cheap price these days and they're finding it at Dollar Tree (DLTR).

The Chesapeake, Virginia-based discounter, which has a market cap of $4.57 billion, sells a range of products including beauty aids, beverages, stationary, and balloons – all priced at $1 or less.

On Wednesday, Dollar Tree reported a 51% bump in its fiscal second-quarter earnings, beating estimates, raising guidance for the full year, and thrilling investors, who moved hard into the company. The stock was up more than 6% in afternoon trading.

In fact, investors clearly think the retailer is a good deal right now. The stock has moved higher, up 14% in the past three months. The question is whether Dollar Tree looks poised to continue doing well even when the tough times pass. As the financial crisis eases, and some kind of normal functioning returns to our economy, will cash-strapped consumers still make a bee-line for a bargain-basement retailer like Dollar Tree?

Analysts believe they will, and they're telling clients to buy the shares.

"Dollar Tree is moving towards our bull case and from our base case," wrote Morgan Stanley analyst Mark Wiltamuth in a research note. "We believe the new customers Dollar Tree is capturing in the downturn will continue shopping there in an upturn."

Wiltamuth rates Dollar Tree "Overweight" with a price target of $52.

Over at Standard & Poor's, retail analyst Jason Asaeda is similarly bullish. "We see DLTR's expanded assortment of everyday necessities driving healthy growth in store traffic from new customer gains and increased shopping frequency," Asaeda wrote.

The analyst lifted his target price to $59 from $50.

For a technician's perspective, we checked in with Katie Stockton, chief market technician at MKM Partners. She noted that Dollar Tree managed to reach a new all-time high this week, exceeding long-term resistance at its 2007 and 2000 highs.

"There is room for a phase of outperformance versus the S&P Retail Index (RLX), which Dollar Tree stores has lagged year-to-date," Stockton argues. "The relative strength comparative is in a long-term uptrend, which suggests pullbacks be viewed as buying opportunities from a technical standpoint."

Former resistance near $46 now can be considered initial support, the technician added.

It's not hard to understand the attraction of discount chains right now like Dollar Tree, Family Dollar Stores (FDO) or Wal-Mart (WMT). Understandably nervous consumers are looking for bargains, as they save more and work off a big debt load.

Joseph Battipaglia, chief investment officer at Washington Crossing Advisors, notes that the household debt to income ratio is 40% higher than the last consumer-led recession in 1990-91, and the debt to equity ratio for households is also 40% higher.

Little wonder then that consumers are snapping shut their wallets: According to a survey released by Deloitte LLP last month, 32% of Americans said they are saving more, up 10% from a year earlier.

And even as the initial aftershocks of this financial upheaval abate, and high-pitched panic moderates to general unease, the dramatic change in how consumers think about spending and saving won't quickly revert to the carefree habits of the go-go years.

"[T]he shift in aggregate spending, savings, and attitudes about debt are likely a longer-term, secular shift and not easily reversed," Battipaglia wrote in a recent research note.

This shift should work to the benefit of discounters like Dollar Tree.

It's not the only dollar store seeing opportunity in the new era of cheap. Dollar General filed to raise as much as $750 million in an initial public offering as KKR, owner of the discount retailer, plans to take advantage of a rebound in equity markets.
No positions in stocks mentioned.
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