Might Be Good to Take FDO Gains

 | Jul 10, 2013 | 1:36 PM EDT
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Family Dollar (FDO) reported in-line Q3 revenues today, but lowered Q4 comparable sales guidance to 2% from 4%.

EPS for Q4 was also lowered to $0.82-0.87 from previous $0.85-0.95. Why did investors cheer at the guide down? Simple. Nobody believed the company could put up a 4% comp on top of its toughest comparison of the year. If they did, they would have been assuming an acceleration in the two-year revenue trend. And by the looks of things, there is no reason to make that leap anytime soon.

Let's consider what is happening to the dollar stores. Dollar General (DG) and FDO have been pressing consumables as a way to drive increased visits. While that may have worked consumables carry a lower gross margin than discretionary. The discretionary part of the story at FDO is not showing any signs of life, so margins should continue to head in the wrong direction. In Q3 the consumables category (including the low-margin tobacco products rolled out last year) increased 15%, while discretionary decreased 3.7%. That mix shift dragged margins down by 110 basis points this quarter. Shrink and higher markdowns didn't help either.

If you benefited from low expectations, more controlled inventory and a Q4 guidance reality check today, taking gains is not a bad idea. With the stock trading at 16x forward VERY questionable earnings estimates, Dollar Tree (DLTR) is looking like a better long-term play.

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