Family Dollar Is No Bargain

 | Mar 28, 2012 | 9:41 AM EDT
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The story of Family Dollar (FDO) is puzzling to the casual observer. This major player in the increasingly important dollar store sector can't quite manage to make it into the good graces of the Street. The company has added new square footage, remodeled older stores, closed poorly performing sites, and upgraded the overall shopping experience.

Theoretically, these should all be positive aspects to the investment thesis on a retailer in an expanding sector. Yet, the stock trades on discounted multiples relative to Wall Street favorites Dollar General (DG) and Dollar Tree (DLTR) -- and believe me, the valuation disparity is well-deserved.

This dollar-store behemoth has taken on too many projects while its competitors are executing well and bathing in the waters of incoming food-stamp revenue and spending by thrifty middle-class Americans. As Family Dollar plays a game of catch-up to its competitors in terms of shopping experience, it's suppressing operating margins and returns.

Coming into the quarter today, I wanted to unearth a tidbit or two to become constructive on the stock, in light of the valuation. Unfortunately, I did not uncover much in the way of encouraging aspects that would convince me that Family Dollar has unappreciated earnings in the near term.

The Unfortunate Family Dollar Shopping List:

  • +4.5% same-store sales result fell short of management's +5% guidance.
  • +4.5% same store sales result underperformed competitors, badly.
  • There was literally no acceleration in the same-store sales trend from December (+4% was called out for that month) despite favorable weather and the value offered by a Family Dollar against a gas-price spike.
  • In two quarters, gross margin has eroded to the tune of 160 basis points (bps), and as sales of low margin goods intensifies in the second half of its fiscal year, the drawdown in gross margin could be greater.
  • Inventory per store increased 11% compared to a 10% rise in the prior quarter. Why was there no work-through of this inventory in three months and with a +4.5% comp?

Family Dollar is banking the attainment of its fiscal-year guidance on winning new customers later this year, as previously unsold merchandise is put on the shelves. But I expect low-income consumers focused on one-stop destinations to save money will continue to shop with their trusted brands, which in this case is a Dollar Tree or a Dollar General.

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