Dollar stores' stocks defying the economic downturn

Recession-wary shoppers aren't the only ones finding big bargains in the dollar stores.

Investors are, too.

The stock market might be suffering one of its most painful slumps ever, but shares of stores that sell the cheapest items are ringing up gargantuan gains.

Family Dollar fdo shares are up 42% this year, not only bucking the 37% drop in the Standard & Poor's 500 but ranking it as the top performer in the index. Dollar Tree dltr and 99 Cents Only Stores, ndn while not in the S&P 500, are doing even better, having soared 46% and 54%, respectively.

Dollar stores — a label they picked up because many of their products sell for $1 or less — are soaring at a time traditional retailers have been sucked into the market downdraft. This year, shares of department store chain Macy's are down 62%, and drugstore chain Walgreen wag is down 38%. Shares of Circuit City cc plunged 60% on Monday alone when the consumer electronics retailer filed for bankruptcy protection.

Changing habits

The worse the economy, the better for retailers of deeply discounted items. Consumers getting used to pinching pennies and saving money are looking for ways to buy what they need for less. "People were conditioned to spend with credit cards and home-equity lines," says Joan Storms, analyst at Wedbush Morgan Securities. "It's not free-flow spending anymore."

That's why Family Dollar reported 8.2% higher revenue in the most recent quarter and 40.7% higher profit — a period when Macy's m revenue declined 3.0% and net income fell 1.4%. The dollar stores are in a sweet spot because they:

•Sell things people always need. The shelves of most dollar stores are stuffed with products consumers buy in good times or bad. When gas prices jumped last year, the dollar stores made themselves more of a regular draw by boosting the amount of discounted food they sold. Industrywide, these stores added freezer cases and coolers so they could offer milk and frozen foods as consumers choked by higher gas prices looked to cut back and make fewer trips.

Family Dollar, for instance, now gets 61% of its revenue from consumables, which includes food as well as paper, candy, snacks and pet food. Half of 99 Cents Only's revenue comes from food, says James Ragan of Crowell Weedon. "People will be shopping for food no matter what," he says.

•Pick up customers and cheap inventory in tough times. The dollar stores benefit when consumers trade down and shop at less glitzy stores. There's a secondary benefit, because dollar stores buy overstock and liquidated merchandise from other retailers, Storms says.

The rising number of bankruptcies has retailers shedding inventory, allowing discounters to get name-brand merchandise that's being sold at fire-sale prices, she says.

For instance, in October, Big Lots big sold $8 million worth of Hewlett-Packard laptops, Storms says. Big Lots sold them for $599, which was $350 less than the retail price. If more electronics stores falter, it's an opportunity for Big Lots to profit from other retailers' woes.

Meanwhile, the dollar stores are finding landlords more willing to cut deals on real estate or to cut rents, since they're having trouble finding tenants. "Real estate is available, and landlords have to negotiate," Storms says.

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