Dollar Tree Should Forget About Family Dollar and Focus on Five Below

Why buy Family Dollar if the bidding war intensifies, and the next Dollar Tree might be in reach?

Sep 4, 2014 at 4:32PM

The reasons for Dollar Tree's (NASDAQ:DLTR) attempt to acquire Family Dollar (NYSE:FDO) are evident: Dollar Tree is nearing its peak for both margins and store expansion, and Family Dollar is a turnaround project with profit upside. Moreover, Dollar Tree management has proven itself to be one of the most efficient in retail -- perhaps ever -- but investors might be much better served if Dollar Tree would abandon its bid for Family Dollar and instead look to a different low-cost retailer for growth.

A dollar store merger
Dollar Tree's bid to acquire Family Dollar for $8.5 billion is not the highest offer, by far -- Dollar General (NYSE:DG) made a bid valued at $9.1 billion  -- but it is reportedly the offer that Family Dollar believes is best. While less in upfront cash, one can't deny that there is something special about how Dollar Tree does business, creating a $0.12 profit on every item sold, each of which cost consumers just $1.

In other words, Dollar Tree must find goods, ship them, sell them, pay staff, and manage all other expenses on $1 items! Not to mention, it must stock shelves with items that consumers actually want that cost $1. And it does this better than its competitors that sell items for $1 and more, offering items such as seasonal decor, brooms, cleaning supplies, and a wide array of discretionary and consumable items for $1. And most importantly, it manages this feat while boasting the highest operating margin -- 12.3% -- within the entire industry, more than double that of Family Dollar.

Therefore, when Dollar Tree says its acquisition of Family Dollar would create $300 million in cost synergies by 2018, it's most likely implying it would improve Family Dollar's distribution channels, improve the product mix, and cross-sell products at both stores while not having the $1 cap at Family Dollar stores. Hence, if Dollar Tree can find laundry detergent, party supplies, and cookware to sell for less than a buck, just think of what it can do with items it can sell for $5, $10, or $20!

A better investment for the future
The only problem is that Dollar Tree is dealing with a tarnished brand. There's a reason Family Dollar is being forced to close 370 underperforming locations. Family Dollar is a company whose comparable-store sales are falling, 2% in its last quarter, with inventories that continue to rise.

Maybe Dollar Tree could reignite the Family Dollar brand, but unfortunately, it is hard to correct negatives such as bad store placement and bad public perception. Investors have suggested for years that Dollar Tree should start a new chain of sorts, one without the $1 limit. Because after all, costs in all industries continue to rise, and the fact is, a dollar doesn't buy as much anymore.

Not to mention, $8.5 billion is a lot of money for Dollar Tree, a company that has just $467 million in cash. At the end of 2013, Dollar Tree reported that its retained earnings were just less than $1.2 billion. So, Dollar Tree will have to raise significant cash via debt or dilute its stock significantly in order to complete its acquisition of Family Dollar. With that said, Dollar Tree might be best-suited focusing its efforts on recreating a new Dollar Tree, or a similar concept like Five Below (NASDAQ:FIVE), a retailer that's popular with teens that sells everything for $5 or less.

Like Dollar Tree, Five Below sells name-brand products like Bic and Coppertone, but because of the $5 cap, it can also sell iPhone covers, chargers, and clothing, including popular brands like Hello Kitty. Lastly, Five Below also has its own manufacturing, or designers it works with exclusively, allowing it to keep costs in check, much like Dollar Tree.

As a result, the concepts of Dollar Tree and Five Below are more aligned, and despite Five Below being a growth company that's aggressively expanding, its operating margin of nearly 10% is second to only Dollar Tree among dollar stores. However, once it becomes a mature company, no longer investing a high percentage of its working capital on expansion, Five Below will likely be the most profitable of the dollar stores.

Five Below the next Dollar Tree?
Not to mention, Five Below's growth trajectory is tracking very much like Dollar Tree's back when it was of similar size, in 1997, as seen below. Based on this fact, one might conclude that Five Below could ultimately grow to become the next Dollar Tree over the next two decades.

 

Dollar Tree Full-Year 1997 

Five Below 2014 Expectations

Revenue

$635 million

$680 million

Revenue Growth YOY 

29%

27%

Comparable Sales Growth YOY 

7.8%

4%

Number of Stores

887

366 *

Revenue Per Store

$715,896

$1.85 million

*Number of stores expected at year-end 2014; current store count is 323.

Five Below may look like a pricey retailer with a market cap over $2 billion, but by giving Dollar Tree the possibility, or opportunity, to create the next $8 billion a year concept, which is the amount of revenue that Dollar Tree currently creates, Five Below might be too good an opportunity to pass up.

Foolish final thoughts
While Dollar Tree does seem to be in the lead to acquire Family Dollar, Dollar General's bid is higher, with estimated savings of $550 million to $600 million annually. Therefore, Family Dollar CEO Howard Levine might not want to merge with Dollar General, but shareholders might not give him a choice.

At that point, the bidding for Family Dollar could get too expensive for Dollar Tree, which could be a blessing in disguise. After all, it would give Dollar Tree the opportunity to pursue Five Below, which, long term, could be the best deal for a company that loves value.

Your credit card may soon be completely worthless
The plastic in your wallet is about to go the way of the typewriter, the VCR, and the 8-track tape player. When it does, a handful of investors could stand to get very rich. You can join them -- but you must act now. An eye-opening new presentation reveals the full story on why your credit card is about to be worthless -- and highlights one little-known company sitting at the epicenter of an earth-shaking movement that could hand early investors the kind of profits we haven't seen since the dot-com days. Click here to watch this stunning video.

Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Five Below. The Motley Fool is short Five Below. 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.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers