Family Dollar (FDO) just unveiled an aggressive growth strategy, but I think the dollar-store mainstay may be getting ahead of itself -- and the stock will likely suffer as a result.
Family Dollar's fiscal fourth-quarter earnings release yesterday was a doozy. Forget the activist-investor-led takeover speculation for just a second. Forget the fact that the latest breakouts to the upside in dollar store stocks have been on less-than-convincing volume. Never in my years covering retail have I seen such an aggressive growth plan. Family Dollar is giving expansion the ol' one-two punch, opening up new stores in its fresh format left and right and overhauling the shopping experience at its existing locations.
Now back to activists Pershing Square and Trian circling Family Dollar like giant vultures on a piece of road kill. Two primary beliefs explain the interest. First, investing this much capital in the business for the expansion is not the best use of shareholder funds, and instead it should be geared to a less-robust growth plan and a better mixture of a higher dividend and a juiced share repurchase plan. Two, Family Dollar's earnings stream is being severely undervalued by the market given the share gain that may result from having fresher-looking stores that resemble a CVS (CVS) in terms of offerings as compared to peers -- and from selling that merchandise to baby boomers.
Family Dollar's Monster Growth Plan for FY12
- 450 to 500 new stores (look out Wal-Mart (WMT:NYSE) and other big-box retailers seeking to open smaller-format stores ... dollar stores are stealing your real estate!), up from 300 in FY11 and 200 in FY10.
- 1,000 renovations, relocations or expansions compared to 972 in FY11 (original goal was 600 to 800).
- Capex will increase between 60% and 73% year over year. Given Family Dollar's FY11 cash burn, it may have to do another debt issuance to support the initiatives on the table. That would bring up a debt-to-equity ratio already nearing 50%.
My Take on the Quarter
Initial trades on Family Dollar had it bidding up only modestly in the premarket, in spite of the clean $0.02 earnings beat that reserved the sharp miss for 3Q. The stock finished lower on the day -- telling. In addition to the FY12 capex assumption likely weighing on the minds and stomachs of investors, there is a sense that FY12 EPS guidance of $3.50 to $3.75 (consensus: $3.59) is a stretch due to Family Dollar's willingness to promote to compete, sales mix shift and disruption in the stores from all of the remodel activity.
My take? Avoid the stock. Here's why:
- Management noted that FY11 was a "very difficult operating environment." I wholeheartedly disagree, the past 12 months have been prime time for dollar stores; Family Dollar has had its own operating issues that have held back earnings flow through and the stock.
- Gross margin of 34.00% (consensus: 34.37%) was down 68 bps year over year on increased promotions and unfavorable sales mix. Nothing new there, but inventory shrinkage increase was a new wrinkle (theft by low-income consumers? inefficiencies in remodel process?). Overall, 4Q gross margin and operating margin were below the FY11 averages.
- Comparable store sales were up 5.6%, outperforming Dollar Tree (DLTR) but below those of Dollar General (DG). Comp growth is slowing for dollar stores following strong year-earlier numbers.
- Continued aggressive inventory management (+9% per store) supported food and consumables initiatives. I appreciate the desire to maintain healthy stocks and inventory to stock new stores, but the company is essentially feeding its negative gross margin trend.
- The company was net cash negative for the year.