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Is This Dollar Store a True Value Play?

Marshall Hargrave
April 28, 2014

Value investing involves buying stocks that have been beaten down to well below what they're worth. However, there are times when stocks look cheap for a good reason. Family Dollar (NYSE: FDO) appears cheap, but is there a good reason for investors to stay away?

The worst investment in the dollar store sector
Earlier this month, Family Dollar missed earnings expectations for the second straight quarter. This time, earnings were off by 11%. All sixteen analysts following Family Dollar have lowered their expectations for the current quarter (ending in May). With the weakness that Family Dollar is seeing, it still trades relatively in-line with Dollar General (NYSE: DG) and Dollar Tree (NASDAQ: DLTR) from a valuation standpoint.

The potential for a buyout of Family Dollar has been buoying the stock's price. However, that talk has faded over the past couple months. Management is in flux as its COO recently left, and the company just appointed a new CMO.

All the dollar stores face certain macro pressures, including consumers' inclination to trade up to Target and Wal-Mart. One potential opportunity for the dollar stores to gain market share in is tobacco products. With CVS Caremark deciding to stop selling tobacco products, these companies should manage to capture some of that new business. Convincing shoppers to buy tobacco products at their stores versus convenience stores will likely lead to sales of other products such as consumables and personal-care products.

What about the other dollar stores?
With the potential issue of consumers trading up from dollar stores, is it wise to avoid the industry altogether? Dollar General remains the dominant leader in the space, with over 10,000 stores. That gives Dollar General an impressive advantage. However, the other aspect is that the company plans to continue expanding. It opened some 650 stores in 2013, and plans to open another 700 this year. Its large and growing store base should help it better fend off the competition.

But it's not just store expansion that's driving growth. Even its current store base is generating impressive sales. Fiscal 2013 marked the twenty-fourth consecutive yea