Family Dollar Still No Bargain

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Another quarter, another minor earnings surprise for low-budget retailer Family Dollar (NYSE: FDO). You can take a look at some of the details here in our numbers rundown, but the version for those of us with the goldfishy attention span is this: Q3 sales up 10%, net income up 5.8%, but diluted EPS up 15.6% on account of a much lower share count from the prior-year period. A share buyback soaked up nearly 4 million stubs during the quarter at an average price of $26.

Let's hit that share buyback, because it gets to the crux of my trouble with Family Dollar -- the stock, not the store. I'm all for share buybacks when the price is right, but I'm not so sure management is getting a great deal on these.

That's because Family Dollar is afflicted by the same problems that hit discount retailers like Wal-Mart (NYSE: WMT), Target (NYSE: TGT), Dollar Tree (Nasdaq: DLTR), and Dollar General (NYSE: DG). We're talking about fuel costs putting a pinch on margins, consumer spending swings, and the need to keep prices low to avoid sending shoppers to the competition.

Here's what that means for profitability.

	2001	2002	2003	2004	2005
Gross Margin	33.5%	33.5%	33.8%	33.8%	32.9%
Operating Margin	8.1%	8%	8.1%	7.7%	5.9%
Net Margin (Excl. Items)	5.2%	5.1%	5.1%	4.9%	3.7%
Free Cash Flow Margin	0.1%	5.4%	1.7%	3%	1.2%

Data from Capital IQ.

This has occurred because while gross margins have held steady, expenses have kept creeping up.

	2001	2002	2003	2004	2005
Depreciation and Amortization Margin	1.8%	1.9%	1.9%	1.9%	2%
SG&A Margin	21.4%	22.3%	25.7%	26.1%	27%
Capital Expenditures Margin	4.4%	4.5%	4.6%	4.1%	3.9%

(Expense line items as a percentage of revenues.)

Returns on equity and capital have also dwindled, although they remain healthy enough.

	2001	2002	2003	2004	2005
ROE	21.6%	20.1%	19.9%	19.6%	15.7%
ROIC	21.2%	19.8%	19.6%	19.3%	15.5%

These are the trends that concern me, much more than the quarterly margin trends my colleague Rich Smith examined in his Foolish Forecast yesterday. He came away thinking this Motley Fool Stock Advisor recommendation might be a good buy as long as it's out of favor.

That, I'd agree with. The trouble is, I hardly think the firm is out of favor. Shares are still trading near $25 each, which is, by my generous free cash flow valuation, about fair value -- especially since I believe the growth estimates baked into that valuation are too generous. And no, the mid-single-digit comps sales predictions from management and "Street-beating" earnings guidance for the upcoming quarter don't change my mind.

So, in other words, this Fool's opinion hasn't changed much since last quarter. Decent business, OK price. You might not do badly investing that way, but as for me; I look for the cheaper buys.

If you think TMF Bent is too big a Mr. Snickerpuss and you're down with the F. Dollar, you might like a look at the other market-beating recommendations in Motley Fool Stock Advisor . You can take a peek for free.

Seth Jayson is cheap enough to shop at Family Dollar, but too cheap to buy the stock. At the time of publication, he had no positions in any company mentioned here. View his stock holdings and Fool profile here. Dollar Tree and Wal-Mart are Motley Fool Inside Value recommendations. Fool rules are here.