Family Dollar to Begin Hitting the Bottle

As the American poet Ogden Nash once wrote, "Candy is dandy, but liquor is quicker," and it would seem to apply to how Family Dollar (NYSE: FDO  ) views efforts to boost profits faster. During the deep discounter's third-quarter earnings call last week, Chief Executive Officer Howard Levine announced that following a trial of beer and wine sales at some 200 stores over the past year, it will roll out alcohol sales nationwide by the end of the year.

Family Dollar is finding its target customer suffering more from the economic malaise still gripping the country. While national policies may be enriching those who are already well off, the low-income consumer who shops at the deep discounter hasn't done well at all, and may even be in a worse condition than before.

And when stripped down to the differences between its rural and urban customers, according to Levine, the gaping chasm is more pronounced for the latter because they're struggling more to find jobs, so Family Dollar's business has been affected more than expected.

Those quarterly results it reported bear that out. Although net sales rose 3.3%, comparable sales were down 1.8% as a result of fewer customer transactions. Comps are an important retail metric because it measures the organic growth achieved by a business and not that attained through store expansion or other artificial means of growing revenues. The consumables segment, particularly refrigerated and frozen foods, but also tobacco, provided the strongest growth the deep discounter enjoyed.

Yet profits were pinched with adjusted earnings coming in at 5.5% of net sales compared to 7.3% a year ago. Expenses were higher, too, with SG&A costs accounting for 28.8% of sales, up from 27.4% in the year-ago period.

That kind of underperformance is what's motivated billionaire investor Carl Icahn to push for a sale of the deep-discount retailer to its rival Dollar General (NYSE: DG  ) . He's found that over the past one-year and three-year periods, Family Dollar has lagged well behind its rivals on just about every metric, showing what he sees as a deep dysfunction in the executive suite.

Now that those plans have encountered a detour, as Dollar General's CEO announced he'd be retiring next year, Family Dollar has an opportunity to show it can turn things around on its own. It adopted a poison pill defense that will seriously dilute anyone's holdings who acquires more than 10% of the company's stock as a preventive measure to keep Icahn from gaining too much sway (the activist investor established a 9.4% position when he announced his demands that the board put the company up for sale). This gives management some breathing room.

Alcohol sales are one avenue for getting customers to return. Dollar General began selling beer and wine several years ago.

Source: SXC.hu.

Levine said Family Dollar has experienced what he's termed "trip consolidation," where customers are buying more items on fewer visits to the store. Alcohol sales have the opportunity to bring them back again and again. Its experience this past July 4 weekend, which was the best it had seen since the trial began, encouraged it to roll out the program nationally.

Its research found that its customers buy about $6 million worth of beer and wine per year, and the goal is to get them to spend those dollars in its stores.

The risk is that like tobacco, alcohol sales carry lower margins. Family Dollar will need to turn beer and wine purchases into opportunities for customers to buy other items while in the store, similar to the ambitions Dollar General has. Gross profits were down in 2013 for the deep-discount leader, but they're seen as the big drivers of traffic that will eventually lead to increases in average ticket prices.

The other big deep-discount rival, Dollar Tree (NASDAQ: DLTR  ) doesn't sell alcohol, or tobacco, for that matter, so Family Dollar (and Dollar General) has the opportunity to gain from the angst exhibited by retail pharmacies over whether they should sell tobacco products. If activists are successful in pushing tobacco off pharmacy shelves, they may turn their attention next to alcohol.

Yet beer and wine sales won't be an easy panacea for Family Dollar. The demographic that shops at its stores are those who shop at Dollar General and Dollar Tree, and those retailers have been experiencing better sales than their rival, suggesting Carl Icahn may be right that at the very least a change is needed at the top.

Certainly the chance to drive more customers to its stores is one it has to take, but if it doesn't have the desired effect, Family Dollar may just find itself on skid row and investors looking for the rehab center Icahn is offering.

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