1 Reason Not to Bite After Family Dollar's Earnings

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Investors apparently liked what they read in Family Dollar's (UNKNOWN: FDO.DL  ) latest earnings report. The discounter saw its stock get more expensive -- by as much as 7% -- after releasing its third quarter results.

Still, while the report was better than expected, it included some news that should have investors cautious about jumping into the stock here. The company is paying a hefty price for those surprising sales gains.

Great sales growth
But first, here's the good news: Family Dollar boosted sales by a solid 9% last quarter. That jump came from a 2.9% rise in comparable store sales, or comps, with an extra 129 store locations chipping in the rest of the gain.

By comparison, discount king Wal-Mart (NYSE: WMT  ) saw a 1.4% drop in comps to start the year. And revenue barely budged, rising by just 1%. Yes, that poor trend has probably reversed since the tax refunds and warmer spring weather finally hit, driving traffic back to Wal-Mart's stores. But Family Dollar still looks to be attracting more of the two-thirds of consumers that say they are dealing with financial headwinds by shopping around for deals.

Costly market share gains
The problem is that Family Dollar has had to pay up for its increasing market share and sales levels. The company's gross profit margin fell by more than a full percentage point, to 34.7% last quarter. In contrast, Dollar Tree (NASDAQ: DLTR  ) booked an expansion of profits, to 35.2%, continuing a trend that's seen it pull away from Family Dollar.

FDO Gross Profit Margin Quarterly Chart

FDO Gross Profit Margin Quarterly data by YCharts

That's all thanks to Family Dollar's bigger worry, its growing dependence on consumables. This category, which includes things like food, health and beauty aids, and tobacco, has been a major growth driver for discount shops as value-conscious shoppers look to trade down from more expensive stores.

Too much food
But Family Dollar has hitched itself to this trend to a much greater degree than competitors. Rival Dollar Tree's consumables category, for example, inched up to 51.4% of sales last year, from 50.8% in 2011. Family Dollar, on the other hand, got a whopping 69% of its revenue from that category last year, up from 66.5% the year before.

Since consumables carry a lower markup than things like home goods and apparel, they tend to hurt overall profitability. You can see the growth in reliance on those products pushing Family Dollar's gross margin down over time.

And consumables are also expensive to stock. The company plans to spend more than $600 million in capital outlays in 2013 on things like fitting stores with freezers and refrigerators. That's about double what Dollar Tree plans to spend with its own renovations.

The stock's recent jump has Family Dollar valued about evenly with Dollar Tree right now, at 19 times trailing earnings. But given all the cash and profitability that it's had to give up in exchange for its sales boost, investors shouldn't be cheering Family Dollar's results.

The death of Wal-Mart
As I mentioned, Wal-Mart started 2013 with a whimper. To learn about two retailers aiming to take down the discounter, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2530454, ~/Articles/ArticleHandler.aspx, 9/27/2016 1:20:57 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 18,231.51 136.68 0.76%
S&P 500 2,159.48 13.38 0.62%
NASD 5,299.00 41.51 0.79%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

12/31/1969 7:00 PM
FDO.DL $0.00 Down +0.00 +0.00%
Family Dollar Stor… CAPS Rating: ***
DLTR $80.16 Up +0.16 +0.20%
Dollar Tree Stores CAPS Rating: ***
WMT $72.33 Up +0.71 +0.99%
Wal-Mart Stores CAPS Rating: ***