June 9 was an exciting day to own shares in Family Dollar (UNKNOWN:FDO.DL), Dollar General (NYSE:DG), Dollar Tree (NASDAQ:DLTR), and Five Below (NASDAQ:FIVE). After news broke that Carl Icahn had acquired 9.4% of Family Dollar and that the company had adopted measures to fend him off, shares of dollar stores moved higher; this was led by Family Dollar and Dollar General, with share price appreciations of 13% and 7%, respectively. But how should the Foolish investor play this news?
Family Dollar and Dollar General might make quite the duo
The reason behind the big share price movements of Dollar General and Family Dollar is that speculation has been circling that Icahn might be trying to arrange a merger or sale of Family Dollar with its larger peer. Whether or not this proves to be true is something that only time will tell, but a deal between the two could create a lot of shareholder value.
Over the past five years, Dollar General has been a pretty phenomenal growth machine. Between 2009 and 2013, the retailer saw its revenue soar 48%, from $11.8 billion to $17.5 billion, as aggregate comparable-store sales rose 32% while store count increased 26%, from 8,828 locations to 11,132.
Family Dollar also did well, but not quite as well. During a similar time frame, the company saw its revenue rise a respectable but relatively slow 40%, from $7.4 billion to $10.4 billion. Like Dollar General, Family Dollar also experienced a nice uptick in sales coming from a high aggregate comparable-store sales increase of 24%. However, the business's top-line growth has been limited by a more modest 19% increase in store count, from 6,655 locations in 2009 to 7,916 by the end of its 2013 fiscal year.
Looking at profits, the division between the two has been even more extreme. During this five-year period, Dollar General saw its net income skyrocket 202%, from $339.4 million to $1 billion, while Family Dollar's rise in profits amounted to just 52%, from $291.3 million to $443.6 million. Aside from higher revenue, the biggest difference between Dollar General's and Family Dollar's bottom lines was the former's ability to control costs more effectively.
Over this time frame, Dollar General reported that its selling, general, and administrative expenses fell from 23.2% of sales to 21.1% while its interest expenses dropped from 2.9% of sales to 0.5%. Family Dollar also reported a decline in its selling, general, and administrative expenses in relation to sales, but this was mostly offset by its cost of goods sold rising from 65.2% of sales to 65.8%.
In the event that Icahn can succeed in merging these two entities, the synergies that could form (assuming that Dollar General can replicate its success in Family Dollar's stores) might amount to after-tax savings of $165 million or more each year. This assumes, of course, that Dollar General can take Family Dollar, convert it into its own stores, and achieve the same profit margin of 5.9% it already does instead of the 4.3% net profit margin earned by Family Dollar in 2013.
We can't ignore Dollar Tree and Five Below
Although most of the attention has been paid to Dollar General and Family Dollar, it would be a mistake to overlook the potential of other players in the industry like Dollar Tree and Five Below. Over the past five years alone, Dollar Tree saw its revenue jump 50%, from $5.2 billion to $7.8 billion, while Five Below's top line grew 328%, from $125.1 million to $535.4 million.
In the case of Five Below, revenue soared because of a 198% jump in store count from 102 locations in 2009 to 304 by the end of its 2013 fiscal year and because of a 56% rise in aggregate comparable-store sales during this period. The improvement in Dollar Tree's top line wasn't nearly as impressive as Five Below's, but it surpassed that of its other peers because of a 31% rise in store count, from 3,806 locations to 4,992, and an aggregate comparable-store sales increase of 28%.
Over this five-year period, Five Below's net income rose by 174%, from $11.7 million to $32.1 million. In part, this was due to the company's rising sales, but it can also be chalked up to an income tax benefit received in 2009. Excluding this, the company's percentage rise in profits was even higher, as its jump in sales was complemented by falling costs in relation to those sales.
Just as in the case of its revenue, Dollar Tree's net income rose slower than Five Below's over this period but was impressive nonetheless. As higher sales and lower costs in relation to those sales positively affected Dollar Tree, its net income jumped 86%, from $320.5 million to $596.7 million.
Based on the data provided, it makes sense that Mr. Market is excited about Family Dollar and Dollar General, but it might make more sense to focus on Dollar Tree or Five Below instead. In the event that Dollar General does engage in a merger or acquisition, the superior growth rates of these businesses could make either one of them an attractive takeover candidate. This is especially true of Dollar Tree, given that the company is only trading at 18 times earnings compared to its rivals shown below: