Carl Icahn and his related funds now have a 9.39% stake in Family Dollar Stores (NYSE: FDO ) . With Dollar Tree (NASDAQ: DLTR ) and its "everything $1 or less" beating up on Family Dollar Stores, the company is in the process of shifting its strategy with or without the help of the activist billionaire. As a Foolish investor, where should you put your hard-earned money between the two?
Dollar for dollar
Only one of these two "dollar stores" is a true dollar store, for now, and that's Dollar Tree. While Family Dollar Stores has many items priced at $1 or less, it also has many more priced higher than $1 and even higher than $5. Slashing over 1,000 items, Family Dollar Stores intends to move more in the direction of Dollar Tree.
Who can blame the company? The dollar-or-less-only Dollar Tree's last results were certainly more attractive-looking than those of Family Dollar Stores despite both facing the same winter-weather headwinds. Dollar Tree saw sales, same-store sales, and diluted earnings per share rise 7.2%, 2%, and 13.6% respectively to record first-quarter levels. Family Dollar Stores, on the other hand, saw calendar-adjusted sales rise just 0.4%, same-store sales plunge 3.8%, and calendar-adjusted earnings nosedive 31%.
Although hindsight is important when establishing patterns in growth, management competence, and trends, the market tends to look through the windshield and not the rearview mirror. Using a share price of $56 for Dollar Tree and $67 for Family Dollar Stores, you can compare their valuations on a numerical basis.
Dollar Tree trades with a P/E of almost 18 and 15.4 based on analyst estimates of $3.14 and $3.63 for the fiscal years ending January 2015 and January 2016 respectively. If these estimates are realized, this represents earnings-per-share growth in the 15-something percentage range for each fiscal year.
Family Dollar Stores meanwhile trades with a P/E of 21 and 19.5 based on analyst estimates of $3.15 and $3.43 for the fiscal years ending August 2014 and August 2015 respectively. This also represents a sizable drop from the fiscal 2013 levels with only an expected 9% rise for fiscal 2015.
This suggests Family Dollar Stores is more expensive on earnings with slower expected growth in the medium term. What about the long term?
Dollar Tree is plowing full steam ahead with bigger stores, more stores, expansion into Canada, and expansion of its Deal$wild card. Deal$is a tiny chain in size (when compared to its larger Dollar Tree chain) that has price points higher than $1.
The company currently has 5,000 Dollar Trees in the U.S. and Canada, but it is targeting a total of 8,000 in the two countries. Deal$finished the quarter at just 217 stores and growing. Bob Sasser, CEO of Dollar Tree, stated that over the next five years, he expects Dollar Tree's growth trajectory will be "among the highest in retail."
Family Dollar Stores, on the contrary, is pulling back. With its disappointing quarter, it announced the closing of 370 stores, the layoffs of certain staff, and that it intends to slow new store growth beginning in fiscal 2015. Based on this, it's hard to make a case that Family Dollar Stores deserves a higher-growth-implied premium P/E over Dollar Tree.
The wild cards
Dollar Tree's wild card is the Deal$chain. Though it's small now, the Deal$chain allows Dollar Tree to expand into "urban high density markets" for which the dollar price point just wouldn't be practical. In high-traffic areas in New York City, for example, the typical rent to retailers is multitudes higher than in other suburban locations. Turning a profit at the $1 price point for those locations would be difficult if not impossible. There is a lot of potential opportunity to use management's successful retail, marketing, and operations experience to expand Deal$in many areas that Dollar Tree can't reach.
For Family Dollar Stores, the wild card is Carl Icahn. When he comes in as an activist investor, he is often able to make changes that extract value. Sometimes this involves changes in management, completely different changes in strategy, and oftentimes it involves shopping a company around to bigger fish with a longer reach. It is often dangerous to bet against a company that Icahn is supporting.
And the winner is...
I have to go with Dollar Tree. Both companies have wild cards, but Dollar Tree has the cheaper valuation in the here and now instead of relying too much on speculation. Neither one has any balance sheet issues that stand out nor excessive strengths so that doesn't play a role.
A bird in the hand is worth two in the bush, and it seems like the story with Dollar Tree is weighted toward how high will the earnings grow and what that growth rate will be. For Family Dollar Stores, it's a question of can it or Icahn turn itself around. For speculative turnaround situations, I want to pay less and not more.
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