While I'm not terribly impressed with the performance of Dollar General
What makes Family Dollar so much more impressive are its steady margins, operating cash flow, and free cash flow. All the data is detailed in the Fool by Numbers published earlier today, so I will instead focus on what factors are driving the improved performance and how likely it is for the company to keep humming along and driving higher sales, margins, and profits.
The company has followed a few strategies to boost its profitability and prospects for growth. These strategies include adding fridges to enable the sales of everyday items such as milk, expanding into urban markets, and a treasure hunt initiative. Strategies such as the cooler initiative are straight out of the Target
These strategies are easy to understand, but I don't believe they have as much potential as finding an urban format that works. Urban shopping markets are not very well served in the U.S.; however, serving them is not very easy, as parking lots and delivery space are much smaller, which means the infrastructure to serve urban markets needs to be different than that used in suburban or rural markets. It's a challenge, but assuming the company can work it out and get the pricing correct, it is an interesting opportunity that 7-Eleven and pharmacies address, though not in all areas and not always at great prices.
Assuming the urban initiative works and that the additional fridges and treasure hunt offerings add a bit to same-store sales, Family Dollar is somewhat attractive. However, with 5% growth in free cash flow priced in for 10 years and 3% growth thereafter, the company isn't tremendously undervalued, so executing on these plans is important. That said, a 10% or 20% dip in price would create some margin of safety and make the company an opportunity worth revisiting.
Here are some more ideas from the bargain bin: