Big Sale at 99 Cent Only Stores?

Like shoppers elbowing their way to the sale bin, investors swarmed over shares of discount retailer 99 Cents Only on April 10. But we at Kiplinger's Personal Finance don't think the stock is anywhere near the bargain some of its merchandise is. After rising nearly 9% in early trading, the stock (symbol NDN) finished the day at $15.28, up 5.3%, after the company reported sales that pleasantly surprised analysts and investors.

Based in Commerce City, Cal., 99 Cents Only operates 251 deep-discount retail stores in California, Texas, Arizona and Nevada. You could expect to find a six-pack of soda, a 99-minute pre-paid phone card or a dozen eggs -- all for 99 cents.

The outfit's quarterly report was undeniably good. Sales for the period ending on March 31 -- the fourth quarter of the company's 2007 fiscal year -- rose 9.4%, to nearly $278 million. Wall Street analysts had been expecting sales of about $275 million. There were more shoppers in the stores during the quarter, spending more money -- an average of $9.41, up from $9.22. Sales at stores open at least a year have risen in each of the past six quarters.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Chief executive Eric Schiffer outlined the company's strategy to become "America's favorite and best-run extreme value store." Part of the strategy involves launching new stores at a faster clip—after having slowed the rate of new-store openings the previous two years.

But here's why we think a rally that pushes a stock within a dollar of its 52-week high is misguided: The company didn't publish what it earned on those fabulous sales -- and hasn't for the past three quarters. That's right; investors haven't any clear evidence of the profitability of the enterprise. The delays stem from a rejiggering of the company's accounting methodology. That’s no simple matter for any retailer. But when auditors tried to reconcile things they found one snag after another, all exacerbated by the more stringent demands of the Sarbanes Oxley law.

An army of accountants later, 99 Cents is close to resolving its accounting issues, and has upgraded its inventory management system along the way. The company filed its annual report for the year that ended March 31, 2006, on April 3, reporting earnings of 16 cents a share. Filling in what blanks they can and relying on company guidance, analysts expect profits of 17 cents a share for just-concluded fiscal 2007 and 31 cents a share in the fiscal year that ends March 31, 2008.

One aspect of the retailer's business will surely be scrutinized when all the numbers are in. Some analysts have questioned its aggressive expansion efforts into Texas, where there are now 41 stores. They say the company charged into the Lone Star State after landing a great deal on a distribution center, only to find that Texas was a tougher market than Southern California. "On the surface you could draw a lot of similarities," says analyst Jeff Sonnek at Friedman, Billings, Ramsey & Co. "They're both border states with higher Hispanic populations and lower income demographics that many dollar stores rely on. But the Texas market is more competitive for that low-income dollar. In Southern California, 99 Cents really dominates -- you see it in every strip mall. But drive around Houston and you see Family Dollar, Dollar General, Dollar Tree as well as Big Pete's DollaRama and Billy Bob's Dollar Store -- it’s a very fragmented market."

The Texas stores were bigger than the average 99 Cents Only outlet elsewhere. But they generated less-than-average sales volume--a double whammy. The company has downsized newer stores in Texas by about one-third, lowering real estate, equipment and personnel costs. CEO Schiffer says the latest store openings in Texas are "performing to our expectations in a smaller store format."

Until he sees the financials, though, Sonnek, like many analysts, is neutral on 99 Cent stock. Says Sonnek: "We've been sitting on the sidelines waiting for clarity. While the company has been publishing positive data points, that doesn't mean that the Texas issues have really been resolved."

Analyst Paul Fontana at Wedbush Morgan believes 99 Cents will be back on track with earnings of 60 to 65 cents a share in the fiscal year ending next March. He likes the company's strong balance sheet and positive cash flow. Nonetheless, he rates the stock a hold. He says the stock should trade at around 20 times earnings. Using the high end of his forecasted range, that works out to just $13 a share.

Although retail stocks in general have enjoyed strong price gains, investors might find a better bargain in two other discounters. In February, Dollar Tree (DLTR)reported surprisingly strong fourth-quarter results. It should benefit from offering frozen and refrigerated items as well as from expanded payment options, ranging from debit cards to food stamps to gift cards. Dollar Tree closed at $38.57 on April 10, up 1.4%. Fred's, a discounter with stores primarily in the Southeast, sells everything from pharmaceuticals to household gadgets to food. It is rolling out pet products and an expanded electronics selection, as well as a new ad campaign. The stock FREDclosed unchanged at $14.39 on April 10. Smart investors may want to shop around.