Family Dollar

The end of the dollar store recovery

August 23, 2013: 10:18 AM ET

Discount stores thrived during the recession, but that may be approaching an end for all the wrong reasons.

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FORTUNE – Dollar stores were one of the few bright spots in U.S. retail during the Great Recession as cash-strapped consumers looked to do more with less. And while many are still going to these discounters for bargains, they're also buying less.

On Thursday, Dollar Tree (DLTR) reported that its second-quarter profit rose 4.6% from a year earlier -- its stock jumped after the discount retailer raised its forecast for the rest of the year, but profits reflected a relatively modest increase for a company that saw double-digit earnings growth for the past five years.

This follows as other dollar stores saw sales slow down from their rapid rise during the recession. The discounters are still generally pleasing Wall Street, but they acknowledge that shoppers are being more cautious about spending. In July, earnings for Family Dollar (FDO) topped analysts expectations, but Chairman CEO Howard Levin warned consumers are cautious about their spending, adding that while sales of items like food and beauty products did well, sales of discretionary items (wants vs. needs) continued to slow. Similarly, Dollar General (DG) noted many consumers had less to spend.

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The outlook not only says a lot about low- to middle-income retailers, but it also highlights the nation's uneven economic recovery; many Americans still aren't benefiting from riding the wave of higher stock and home prices. This shouldn't be that surprising, says Joe Feldman, analyst at Telsey Advisory Group, a brokerage firm focused on consumers. Dollar store shoppers are generally less likely to own homes. And they're less likely to be tied to the stock market, with the exception for some with 401(k)s.

Dollar stores thrived during the darks days of the recession, and it's easy to assume that sales would slow when the economy improves. Some of that has happened, but contrary to what many expected, sales are also softening because of some very gloom reasons: For one, Congress discontinued the payroll tax cut in January. Which means the average dollar store shopper earning $50,000 or fewer a year will be seeing at least $1,000 less in their paychecks this year, says Ken Perkins, analyst at Retail Metrics. This suggests middle and lower-income households are being left behind the economic recovery.

It also doesn't help that disposable personal income grew only 3.3% last year, the lowest on record excluding 2009's slump, Perkins adds. More than that, dollar stores did well during the recession partly because that was also a period when many chains spruced up stores and expanded into food and grocery items. That market, however, has become more competitive as drugstore chains, such as CVS (CVS) and Walgreen (WAG), enter the grocery business.

It was supposed to be a positive sign when the dollar store recovery ended. As it turns out, the reasons are more disheartening.

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