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Friday, May 27, 2022

Today's newsletter is by Myles Udland, senior markets editor at Yahoo Finance. Follow him on Twitter @MylesUdland and on LinkedIn.

Inflation is at 40-year highs.

The challenge this presents consumers has manifested itself in different behaviors across the economy, and a segment of the retail landscape that appears to be a winner amid these shifts are the national dollar store chains.

On Thursday, both Dollar General (DG) and Dollar Tree (DLTR), the two largest dollar store chains in the U.S., reported results for their most recent quarter, and both companies raised their forecasts for the full year.

Shares of both companies rose more than 13% on Thursday.

Seen a certain way, these results are a concerning complement to what we heard from prominent retailers Target (TGT) and Walmart (WMT), which flagged slowing sales and bloated inventories last week.

In recessions, discount retailers like dollar stores often see traffic and sales rise as consumers "trade down" to save money as finances tighten. On a call with analysts, Dollar General CEO Todd Vasos said consumers have become more "intentional" with their purchases amid high inflation.

But taking into account the signal airlines and other travel players are sending about the desire of consumers to spend, it seems there's a bit more to the big box story. Speaking with analysts on Thursday, Vasos said "employment is still very healthy across all cohorts of customers that we serve," noting the differences between this environment and the recession that followed the financial crisis in '08-'09.

And when we look at the driver of sales growth at both dollar stores, we see consumables — i.e. food and grocery items — leading the way.

At Dollar General, consumables sales grew 9.1% in the latest quarter, the only one of its four major categories — including seasonal, home products, and apparel — that grew sales during the period. At Dollar Tree, consumables sales grew 8% in the quarter against a 6.5% overall sales increase for the company.

Target and Walmart both have considerable food and grocery businesses — at Walmart, a little over 50% of U.S. sales are food and grocery; at Target, that mix is closer to 20%.

At last check, headline inflation was running at 8.3% in April, but the cost of food is rising even faster — food prices last month rose 9.4% over the prior year.

Combine a frequent purchase with faster-than-baseline inflation, and we see where dollar stores are fitting into the picture for consumers during this cycle. We also get a sense of why the takeaway from some softness at Walmart and Target is a bit more nuanced than a simple sign that consumer strength is beginning to completely crack.