Which Dollar Store Is Still in Trouble?

The dollar-store industry could be in trouble as the economy strengthens, but this particular company is doomed either way.

Feb 4, 2014 at 3:58PM

Family Dollar Stores (NYSE:FDO) is one of the three big dollar stores operating in the U.S., but it still remains the worst investment of the trio. Family Dollar managed to miss fiscal 2014 first-quarter earnings, and comparable-store sales dropped by 2.8% year over year. As a result, full fiscal-year 2014 earnings-per-share revisions over the last 30 days have been revised downward from $3.98 to $3.41.

It looks like the interim will be weak for Family Dollar given the company's struggles with trying to find a viable marketing strategy and a growth strategy that will work in an improving economy. As employment rises and consumer spending increases, individuals will be trading up to the likes of Wal-Mart and Target.

A step in the wrong direction when it comes to marketing
Family Dollar appears to be getting even more aggressive when it comes to promotions. It recently traded in its $5-off when you spend $25 coupons for $3-off when you spend $15. However, the average basket size at Family Dollar remains a mere $10.

Family Dollar is also cutting back its level of circulars, starting in Q2 2014. During 2013, the company issued 33 circulars. This move might prove to be troublesome, as J.C. Penney made a similar move in 2012 but has since backtracked to offering promotions.

The industry is flush with competition
While Family Dollar is competing with the major department retailers, like Wal-Mart and Target, it's also battling Dollar General (NYSE:DG) and Dollar Tree Stores (NASDAQ:DLTR), which also operate in the dollar-store industry. All three dollar store stocks are up more than 100% during the last five years.

Yet, again, as the economy rebounds, investors might be looking to trade up--however, the companies are still increasing their store numbers. PWC and Kantar Retail believe that discount retailers will grow stores the fastest among the retail space. The continued increase in the number of stores in the industry is not a positive when the industry sales could start to weaken in a rebounding economy. 

Dollar Tree, the smallest dollar-store operator, managed to see solid 9.5% growth last fiscal year. However, it missed revenue consensus and the growth was primarily driven by store openings. Retail square footage was up 7% thanks to the opening of more than 110 stores.

Dollar General is the leader in the dollar-store space by store count, boasting more than 11,000 retail locations. It expects to continue growing its real estate footprint by more than 6% annually over the interim. It's also planning to open more than 600 stores this year and remodel in excess of 350.

On a positive note, Dollar General does spend the lowest amount of revenue on selling, general, and administrative expenses. Over the trailing-12 months, Dollar General has spent 21% of its revenue on SG&A. Dollar Tree spends 23%, and it's no surprise that Family Dollar is spending the highest, at 28%. This high amount of SG&A spending is likely the reason that Family Dollar is looking to curtail circulars in 2014. However, in this case, the lowering of SG&A might also have an impact on the company's top line, leading to slower revenue growth.

Bottom line
Raymond James, the investment firm, believes that Family Dollar should be trading at a discount to major peers, given the company's inferior sales productivity. Family Dollar's price-to-earnings-to-growth ratio is a very high 3.3. Anything above a 2 is considered expensive. By all accounts, Family Dollar is the worst positioned of the three. However, Dollar General only trades at a 1.1 PEG ratio and has the lowest price-to-earnings ratio at 15.4 times. Don't forget it also has the largest store base of the three. Investors should avoid Family Dollar and invest in Dollar General for expsoure to the industry.

Which retailers are actually doing ok?
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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