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GROWING ON TREES

Dollar Tree turns $1-or-less stores into a $2 billion business

By Kimberly Pfaff

Everyone loves a bargain, which in part explains the success of Dollar Tree Stores, the Chesapeake, Va.-based discount retailer specializing in items for $1 or less.

Discount store operator Dollar Tree prefers to locate in strip centers near traffic generators such as Wal-Mart, Kmart and dominant supermarket chains.

Merchandise changes weekly at Dollar Tree, though the chain always stocks a core group of items, including household cleaners, and health and beauty items.

Calling itself the “modern-day equivalent of the traditional variety store,” Dollar Tree’s locations are stocked with housewares, candy and food, toys, party goods, cleaning supplies, health and beauty aids, candles and more. But if that sounds like so much small change, think again. Sales for 2000 rose 25% to $1.7 billion, and projections call for an increase this year of about 22%, to just over $2 billion.

The company is also on a steady expansion course. Dollar Tree currently operates 1,781 stores in 36 states; the chain has added over 200 stores in each of the last two years, and is on track to open about 275 new locations this year.

“They offer such great value,” noted Ralph Jean, a senior research analyst with Charlotte, N.C.-based First Union Capital Markets. “People do like getting a good bargain, and when they’re selling something for that fixed price point, your risk of getting a dog is low.”

“They’re just a high-traffic, well-run company. They’re great operators, and their stores are very well-merchandised,” said Thornton Anderson, director of leasing at Atlanta-based IRT Property Co., which operates 90 strip centers. The firm has nine Dollar Tree stores, and has worked with the chain for nearly 10 years. “For the value-conscious consumer, they’ve been real successful. We’d be delighted to work with them again. They’re a fantastic retailer, and they’re good for our shopping centers.”

At just under 2,000 stores, Dollar Tree is a major player in a category that’s also home to many mom-and-pop operations. But it’s not the largest in this space; competitors Dollar General and Family Dollar each have nearly 5,000 locations. “There is precedent to get to 5,000 stores,” acknowledged Jean. “The good news is that these stores have a tight drawing radius of about one to three miles, so you can put a lot of stores into an area without cannibalizing them.”

As Dollar Tree sees it, the difference is all in the product. “The key is getting good merchandise,” said Bob Gurnee, vice president of real estate for Dollar Tree, who cites the firm’s longstanding relationships with vendors and manufacturers.

Merchandise changes weekly at Dollar Tree, and the products are generally first-quality items. Unlike many retailers in this space, who have taken a closeout approach, Dollar Tree limits closeouts to about 10% to 15% of its mix.

Dollar Tree stocks a core group of items, so that they are always available, such as household cleaners, paper and plastics, food, candy, and health and beauty aids. “There’s a certain percentage of goods that you can count on finding in our stores,” noted Gurnee. “With other items, we might carry one brand this week and a different brand another week.”

In addition, Dollar Tree has ventured into private-label manufacturing for products such as resin figurines, toys, housewares, and health and beauty aids. “They find a product they think their target customer wants, and they’ll take it to their vendors in Asia, Italy, wherever, and say ‘Make this for me,’” said Jean.

The firm’s main customers are middle-income women — “basically the same customer that shops at Wal-Mart, Kmart and Target,” said Gurnee. And these consumers are loyal, he noted, adding, “We have customers who know which day our trucks arrive with deliveries at the store, and they’re waiting outside.”

The vast majority of Dollar Tree stores are in strip centers, with malls making up about 15% of the company’s store base, and downtown locations accounting for a very small percentage. “For the foreseeable future, it will continue to be a strip center base,” said Gurnee. “We look for traffic, and we love traffic generators like Wal-Mart and Kmart, as well as dominant grocery chains. We also look for visibility, and if we can get a big store in a location that’s highly visible from a road with good traffic, we know we’ll be successful.”

Within a mall setting, he added, “Typically, we’re looking for traffic, activity and strong anchors. We’re probably in more Sears-anchored malls than anything else. We typically like to be as close to the food court as we can, although very often we are somewhere near the anchors.”

Analysts note that the firm’s focus on select locations has helped play a major role in its success. “Dollar Tree has about 35% of its stores next to either Kmart, Wal-Mart or Target, and those stores spend a lot of money on advertising to drive foot traffic,” said Jean. “They’re positioned next to some of the best retailers in America, and they’ve benefited from that also. So it’s a combination of their offering a great value and being a convenient place to shop.”

In the past few years, the company has also been on a steady course of acquisition. In 1998, Dollar Tree merged with 98 Cent Clearance Center, and added 66 stores throughout northern and central California and Nevada. In June 1999, the retailer merged with the 24-store Only $One of New York City. Most recently, in May 2000 Dollar Tree acquired the 107-store Dollar Express chain of Philadelphia.

“They’re leaders in the dollar business,” said Bill Hecht, vice president and national leasing director for The Rouse Co., Columbia, Md. “They’ve shown that for quite some time.”

Rouse has about seven Dollar Tree locations, all in enclosed malls. “We have them in solid B or A-minus centers,” said Hecht, adding, “We would not have much of an interest in putting them in our highest centers, nor do they want to be in that type of location.”

As for the image factor of placing a dollar store within a mall, Hecht noted that’s simply not an issue. “We don’t have a problem with respect to the image of a dollar store, because ultimately even middle- to better-middle-income families will shop a dollar store for impulse kinds of purchases — games for the kids, knickknacks, etc.”

In the past, Dollar Tree stores have typically averaged between 3,500 and 6,000 square feet. Now, however, the company is focusing on stores of 5,000 square feet and up, and adding superstores ranging from 9,000 to 12,000 square feet. While some investors have been critical of the addition of larger stores, analyst Jean believes it’s a sound long-range strategy.

“Dollar Tree’s small-store format has a 115% return on investment [ROI] in the first year, while the larger stores have a 97% first-year ROI,” he noted. “So, some people have said, why are they doing something that brings in less? Well, first of all, 97% is a darn good number — a lot of retailers can’t even do that. And where Wall Street’s missing the boat on this is that in years three, four and five, the larger stores will generate a higher ROI than the smaller ones.”

He added, “Whenever you’re doing more volume through a store, which they will do through the larger-format stores, you’re also getting greater leverage from your fixed assets — distribution facilities, rent, etc. I think it’s a great long-term strategy.”

The average ticket is about $6 in smaller stores, and about $8 in superstores. The company operates primarily on a cash basis, with just over 10% of the transactions completed by check. While Dollar Tree has experimented with credit cards, mainly through its acquisition of other retailers that accepted them, it does not accept credit cards as a rule. Said Gurnee, “It’s just simpler and less expensive for us to deal with cash and checks.”

The firm’s sales per square foot, which topped at $200, have declined slightly, to $193, with the addition of the larger stores. But analysts remain positive about Dollar Tree’s prospects. “[The larger stores] have caused an initial deterioration in sales,” affirmed Jean, “but that should ramp back over time.”

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