Why This Dollar Store Isn’t Worth Your Dollar

While the dollar stores have done great over the last half-decade, the tide could be turning.

Jan 10, 2014 at 11:43AM

Of the major dollar-store chains, Family Dollar Stores (NYSE:FDO) is likely to be the biggest disappointment of 2014. The speculated buyout hasn't, and likely won't, come to fruition. Family Dollar continues to search for new ways to differentiate itself from other major dollar stores, namely Dollar Tree Stores (NASDAQ:DLTR) and Dollar General (NYSE:DG).

As mentioned, Family Dollar was the topic of a potential buyout back in August of last year. Billionaire Nelson Peltz tried to purchase the company two years ago, and in July a standstill agreement with Peltz ended. As a result, options prices suggested record takeover speculation in August, according to Bloomberg. Various private equity names were floated as suitors, as well as major rival Dollar General. Yet, despite the argument that there would be various cost synergies between Family Dollar and Dollar General, the fact that Family Dollar's margins and cash flow continue to deteriorate has kept Dollar General away.  

Family Dollar is already disadvantaged enough, but given its key customers are susceptible to economic conditions, available credit, and unemployment, a rebounding economy in 2014 would spell bad news for all major dollar stores.

Family Dollar's management team guided comp-store sales to be down in the single digits for the fiscal first of quarter 2014, and they believe the next few quarters will be tough, in part due to economic pressures, but more so because of internal missteps. For instance, inventory has been on the rise and turnover is down.

Family Dollar's gross margin for the trailing-12 months is at the lowest it's been in the last decade, at 34.2%. There's a lot of execution risk to get that back up, which includes relying more on private labels. However, as mentioned, one of the biggest issues is its management problems. Management turnover was in the high 30% range last quarter, up from the mid-20% range year over year, suggesting morale is quite low at the company.

Family Dollar is outgunned
Dollar Tree is the smallest of the major dollar stores. Meanwhile, Dollar General is the dollar-store leader, and it continues to succeed with its expansion. Either one of these dollar stores appears to be a better bet than Family Dollar.

Over the last three months, Family Dollar's fiscal 2014 earnings-per-share estimates have moved down from $4.13 to $3.98. The stock still trades with a 1.5 PEG, the highest among its peers, whereas Dollar General's and Dollar Tree's are both at 1.2.

In the most recent quarter, Dollar General managed to post same-store-sales growth of 4.4% year over year, crushing the likes of Dollar Tree and Family Dollar in their respective quarters. In addition, all the major dollar stores have been adopting consumables, so Family Dollar will not get any major advantages with its consumable/refrigerated adoption.

Although Family Dollar was a first adopter of tobacco products, Dollar General has since moved to offering tobacco in its stores and is seeing great success. That's because it's not just tobacco sales that the company is seeing a rise in, but the fact that customers are coming in to buy tobacco and end up shopping for other items.

In more recent news, Family Dollar's earnings announcement from this week showed that earnings and sales missed during fiscal 1Q 2014. In addition, it lowered fiscal 2Q EPS guidance to $0.85-$0.95, compared to consensus of $1.21. The company also noted that its President and COO, Michael Bloom, was leaving the company to pursue other opportunities. 

Bottom line
Family Dollar has a number of headwinds that should make it the poorest performer of the major dollar stores, one of the biggest being the amount of competition in the market, not to mention its own internal struggles. The company went through a major product-offering restructuring back in 2012, and management has not been very receptive. However, Dollar General, the dollar-store leader, appears to be quite a solid investment, with plans for continued store growth in 2014.

 Will a dollar store take down Wal-Mart?
To learn about two retailers with especially good prospects, 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.

Marshall Hargrave has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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