Market Overview

These Retailers Could Get Crushed by the Congress

The payroll tax cut debate is heating up in the U.S. Congress right before the holidays, as the politicians are trying to find a mutual ground. President Obama and the democrats have been defending the pay roll tax cuts, whereas the republican politicians have been reluctant to extend them. The debate is a part of the larger budget and debt reduction discussion, in which the two parties have been unable to come to an agreement.

According to a CNN article, there has been some progress recently and the senate leaders think the deal is still possible. However, the Americans remember well the recent failure of the Super Committee to come up with a compromise, which is a great example of the current state of ineffectiveness in Washington. These political events have been widely covered by Benzinga's real-time news service, Benzinga Pro.

The whole debate might seem pointless to the traders who do not pay the payroll taxes on the capital gains. So, why should you pay attention to the issue? According to the CNN article, “Failure to pass the payroll tax measure, a major part of President Barack Obama's job creation plan, would cost working Americans an average of $1,000 in higher taxes next year.” This would significantly reduce the American consumers' purchasing power and affect several retailers.

A $1,000 decrease in annual income would most likely hurt the consumers in the lowest income brackets, who have already seen their relative income diminish. Benzinga took a look at three companies that might be affected, if the lower income consumers lose a portion of their income:

1. Dollar General Corp (NYSE: DG)
Market Cap $14 billion
P/E Ratio 20.28x

Dollar General is a discount retailer that operates 9,414 stores located in 35 states. The stock has performed extremely well this year and is up over 30 percent year-to-date. Dollar General is currently trading above its 50-day and 200-day moving averages.

The company might see a slower sales growth in the future, if its customers lose a portion of their income.

2. 99 Cents Only Stores (NYSE: NDN)
Market Cap $1.55 billion
P/E Ratio 20.16x

As of April 2, the 99 Cents Only Stores operated 285 retail stores with 211 in California, 35 in Texas, 27 in Arizona, and 12 in Nevada. The shares are up nearly 40 percent year-to-date and the stock is trading above the 50-day and 200-day moving averages and is also at its 52-week highs.

Also 99 Cents Only Stores might see a slower sales growth in the future, if customer loses a portion of their income.

3. Dollar Tree (NASDAQ: DLTR)
Market Cap $9.78 billion
P/E Ratio 21.92x

As of January 29, Dollar 4,015 stores in 48 states and the District of Columbia. It also has a small number of stores in Canada. Dollar Tree has had a phenomenal performance this year, as the stock is up 45% year-to-date. The stock is currently trading above its 50-day and 200-day moving averages.

Dollar Tree's exposure to Canada might offset some of the impacts, if the U.S. consumers' purchasing power diminishes even more. However, the vast majority of the company's sales come from the United States, so the lower purchasing power in America might significantly impact the company.

Although, the potential decrease in the low-income consumers' income seems likely to hurt the dollar stores, it might also bring them new customers. The middle-class shoppers who currently shop at Target (NYSE: TGT) and Wal-Mart Stores (NYSE: WMT) may have to scale back and look for stores that have even lower prices.

It also seems likely that the higher end retailers will not be affected by the potential expiration of the payroll tax cuts, as the payroll tax has a smaller impact on the high income consumers. Thus, the stores like Tiffany & Co (NYSE: TIF) and Coach (NYSE: COH) will most likely continue steady performance no matter what the outcome of the payroll tax cut debate is.


ACTION ITEMS:

Bullish:
Traders who believe that the payroll tax cuts will be extended might want to consider the following trades:
  • Go long low-end retailers.
  • Go long SPDR S&P Retail ETF (NYSE: XRT).
Bearish:
Traders who believe that the payroll tax cuts will not be extended may consider alternative positions:
  • Short dollar stores and other lower end retailers.
  • Federal Governemnt revenue increase may be bullish for the U.S. dollar. PowerShares DB US Dollar Index Bullish (NYSE: UUP) is one way to play this.
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

You can follow me on twitter @TuomoKallio.

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