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Family Dollar Discounts Its Way to Gains

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Low costs are hot in retail, with the recession having left wary consumers focusing on rock-bottom deals. To capitalize, stores such as Dollar General (NYSE: DG  ) and 99 Cents Only Stores (NYSE: NDN  ) have dished out plenty of cheap alternatives on a growing scale. Discount retailer Family Dollar (NYSE: FDO  ) is no exception, but even though it posted a 6% rise in third-quarter earnings, lower-than-expected sales in seasonally sensitive categories combined with inflationary pressures to leave the stock short of analysts' expectations. The stock closed down 1.5%. 

Long live the discounters!
Family Dollar revenue increased 7.8%, to $2.15 billion this quarter, helped by consumables and home products. However, higher freight costs, more discounts, and low margins on those consumables led to a 36-basis-point decline in gross margin to 36.2%. Same-store sales also saw a smaller year-over-year increase -- up 4.7%, compared with 7% a year ago.

Budget-conscious shoppers aren't exactly loyal customers. Their commitment goes only so far as a store's willingness to beat competitors on price, which is a dangerous game for investors. So to compete for consumers' attention, Family Dollar has had to increase product discounts -- and at a time when higher freight costs are already pinching the bottom line. Competitor Dollar Tree (Nasdaq: DLTR  ) has said that higher gasoline prices will weigh on its current quarter's results.

The Fool's takeaway
Still, having put up consistent performances in past quarters, this retailer has been able to weather the industry pretty well. Management expects same-store sales to grow in the 5% to 7% range. And since discounters are pulling in the crowds, this stock could be a compelling investment. Pershing Square's Bill Ackman thinks so and has put his money behind the stock. It's worth keeping an eye on this one.

Fool contributor Debarati Bose doesn't own any shares in the companies mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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