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Great expectations for Dollarama and Costco results

A shopper wheels his cart from a Costco Wholesale store in Arlington, Virginia August 6, 2009. Costco Wholesale Corp reported a bigger-than-expected 7 percent fall in July same-store sales hurt mainly by a strong U.S. dollar-------- U.S. wholesaler Costco Inc. will report its quarterly earnings this week


Two retailers that have shown they can deliver big profits in times of economic stress will post results this week.

In Canada, Dollarama Inc. will unveil third-quarter numbers on Wednesday. The nation's largest discount retailer has beaten expectations over the last two years. This time around, analysts are expecting sales to show a 12-per- cent rise from a year earlier, to $398-million. They are also looking for a 21-per-cent gain in profit, to 52 cents a share.

Dollarama's focus on cheap goods makes the stock a smart defensive play in times of economic uncertainty. But its double-digit gains also make it a growth stock in a period of generally slow business expansion. This combination has given the company a rich valuation compared with most other retailers.

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Dollarama shares trade at 21 times earnings. In comparison, shares of Loblaw Cos. Ltd., Canadian Tire Corp. Ltd. and Shoppers Drug Mart Corp. each go for between 11 and 15 times earnings. No surprise then that Dollarama stock has risen by 42 per cent this year, compared with a 10-per-cent decline for the S&P/TSX composite index.

Canaccord Genuity Corp.'s Derek Dley is one of the most bullish analysts following Dollarama. He is forecasting gains above the consensus, including a 13-per-cent increase in revenue. He is one of six analysts who consider the shares a buy.

"We believe the company's store network expansion opportunities, ability to manage margins in periods of rising costs, healthy same-store sales growth, robust free cash flow generation, and superior [return on equity]supports Dollarama's premium valuation," he wrote in a note last week.

With 680 stores across Canada, Dollarama has more locations than its five largest competitors combined, and it continues to add about 50 new sites a year, Mr. Dley notes. He thinks the Canadian market is underserved with dollar stores compared with the U.S. landscape, leaving the company with lots of space to grow.

A couple of years ago, Dollarama began selling a handful of products above the traditional $1 threshold and gradually increased the trend. At the end of the second quarter this year, 48 per cent of the company's sales came from products costing more than $1, and in the most recent quarter that portion likely rose above 50 per cent, Mr. Dley said.

But Kenric Tyghe of Raymond James Ltd. says that for Dollarama to maintain its high valuation, investors are going to want to see that the company isn't just boosting same store sales by raising prices. They will want to see that the company is getting more people into its stores, which have suffered three straight quarters of declining traffic, he notes.

Mr. Tyghe is one of just two analysts who are neutral on the stock.

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On Thursday, U.S. retailing giant Costco Wholesale Corp will report. Although Costco is not a discount retailer, it has also traditionally weathered weak economic conditions well. The Issaquah, Wash.-based company has always been able to sell good quality supplies in bulk to small businesses and families.

When it posted fiscal fourth-quarter numbers in October, the company took the sting out of an earnings miss by announcing it was raising its membership fee. The hike – the first in five years – will generate an extra $110-million (U.S.) a year.

For the most recently completed quarter, analysts expect profit to expand from the year-earlier period by 12 per cent on revenue growth of 10 per cent. Those expectations look solid based on November sales results. While many of its rivals struggled, Costco stood out by exceeding analysts' expectations. It reported a 9-per-cent increase in same-store sales, compared with expectations of 6.5 per cent.

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