It's shaping up to be a dreadful year for the retail industry. American shoppers generally soldier on through thick and thin, but sales were down more than 2 percent in the first four months of the year, and the fancier the store, the uglier the results. Sales at Tiffany's Fifth Avenue flagship were off 42 percent in the most recent quarter.
It's also been an ugly period for the private-equity honchos who work just a gemstone's throw from Tiffany's. Executives at the Blackstone Group and Kohlberg, Kravis & Roberts, it turned out, were no smarter than the rest of us. In 2006 and 2007, they used loads of debt to purchase huge, cyclical companies at absurd valuations. Many of those firms are now struggling. Things are getting so bad that some private-equity barons may be forced to sell their seventh homes.
In late May, KKR reported that it lost $1.2 billion in 2008. And as of March 31, 2009, the value of the five large companies it bought in 2007 was off 20 percent to 50 percent. In fact, only one of KKR's 2007 mega-deals was in the black, and it couldn't be farther away—geographically, socioeconomically, culturally—from KKR's Manhattan headquarters. It's Dollar General, America's largest chain of 99-cent stores. Not surprisingly, all the various chains of superdiscount stores are thriving in the recession. At Dollar Tree Inc. (3,667 stores), earnings were up nearly 38 percent in the most recent quarter. In its most recent quarter, Family Dollar Stores (6,654 locations) said same-store sales were up 6.2 percent. Both companies' stocks are higher than they were when the market peaked in October 2007. And Dollar General (8,400 stores, $10.5 billion in 2008 sales) is performing even better. KKR says the value of its stake in the company is up 30.8 percent since July 2007, when KKR and several other partners completed the $7.3 billion acquisition.
Back then, Dollar General, which traces its origins to a Kentucky wholesaler, seemed an unlikely target for the affections of an urbane billionaire like Henry Kravis, who founded KKR along with Jerome Kohlberg and George Roberts. Based in Goodlettsville, Tenn., and concentrated in the South and Appalachia (976 stores in Texas, 472 in Alabama), Dollar General catered to shoppers who found Wal-Mart too inconvenient and too pricey. And in the summer of 2007, downscale retailers were even more déclassé than usual. After all, Americans, primed by the rising asset values and cheap credit of the boom, were relentlessly trading up. But once the credit crunch took a bite out of consumers' wallets and egos, the pendulum began to swing.
KKR had the luck to acquire Dollar General just as thriftiness was returning to the culture. It brought in a new CEO, Rick Dreiling, who had previously run the Duane Reade drugstore chain. Along with several new executives and KKR's in-house retailing experts, Dreiling focused on the basics of retailing. Rather than simply pile up cheap bottles of detergents and ultracheap clothes—truth be told, only about 30 percent of the items it stocks retail for less than a buck—Dollar General began to think about how the firm could be more relevant to its customers. For example, even though most of Dollar General's stores are in the South, which is hard-core Coca-Cola country, the stores had carried only Pepsi. Dreiling stocked Coke and upgraded the quality of private-label products. The new team systematically examined the items offered—about 7,500 per store—and eliminated less profitable ones. Essentially, the team tried to remodel the bargain basement into a condensed version of Wal-Mart—tightly run, more convenient, less overwhelming.
It's working. More customers are coming to Dollar General, and they're visiting more frequently and spending more money. After rising 9 percent in fiscal 2008, same-store sales grew by 13.3 percent in the first quarter, better than smaller rivals or Wal-Mart. Most significantly, profits aren't being driven by heavy discounts. In the most recent quarter, gross profits were 30.8 percent of sales, compared with 25.8 percent in fiscal 2006. And the chain is expanding rapidly. This year, it plans to open 450 new stores, creating 4,000 jobs.
Of course, there are limits to the growth. Connecticut remains a Dollar General-free zone. Management knows that some shoppers won't step foot in them. And when (if?) the economy turns around, there's no guarantee many of its customers won't start trading up.
Until that day, however, Dollar General remains a rare green shoot for KKR and for the retail industry. Dollar General and KKR's executives are hesitant to crow on the record about the chain's success. But don't chalk it up to modesty. The run of good results may have set the stage for an event that has become as rare as a Wall Street banker picking up detergent at a Dollar General: an initial public offering.
A version of this article also appears in this week's issue of Newsweek.