Source: Wikimedia Commons

Heading into earnings on July 10, some investors are probably kicking around what to do with Family Dollar (UNKNOWN:FDO.DL). However, Carl Icahn isn't likely to be one of them. After he disclosed his 9.4% stake in the discount retailer after the market closed on June 6, the shares of the company have done quite well and currently sit 9% above their closing price that day. According to sources, Icahn wants to see Family Dollar sell itself immediately to a competitor like Dollar General (NYSE:DG), but is it possible that the business may show him in this upcoming earnings release that the situation isn't all that bad?

Icahn isn't happy, but he is hopeful!
While many investors like Warren Buffett like to buy into a strong, healthy enterprise at a discount and see the company do well over the long run, activist shareholders like Icahn prefer to buy into a troubled business with the goal of maximizing shareholder value. In the case of Family Dollar, Icahn believes the best way to create this value is to sell the chain lock, stock, and barrel.

The big reason behind his decision to press for a sale is that the business has significantly lagged rival Dollar General. In 2013, Family Dollar reported sales per square foot of $189, 14% less than the $220 per square foot reported by Dollar General. Admittedly, the disparity is better than the 19% spread five years ago when Family Dollar had sales of $158 per square foot versus Dollar General's $195, but even faster growth in this category doesn't seem to do the business justice in Icahn's eyes.

(sales/sq. foot) 2013 2012 2011 2010 2009 Change
Family Dollar $189 $181 $174 $165 $158 19.6%
Dollar General $220 $216 $213 $201 $195 12.8%

Sources: Family Dollar and Dollar General

This, combined with a 2013 net profit margin of 4.3% compared to Dollar General's 5.9%, and a 40% increase in sales from $7.4 billion to $10.4 billion at a time when its rival grew its top-line performance by 48% from $11.8 billion to $17.5 billion, suggests that Family Dollar hasn't been doing enough to keep up with the competition. While it's possible that Family Dollar could see its fortunes improve through less extreme measures than a sale of the business, a sale would create immediate value and would allow the acquirer an opportunity to see both sales and margin improvement.

But is action needed? Heck yes!
In the event that management can start showing some strong results, the business could avoid a further push for its sale. Unfortunately though, this doesn't appear likely any time soon. For the upcoming quarter, analysts expect Family Dollar's profitability to decline with sales growth at a snail's pace.

Source: Family Dollar

If analysts are correct, Family Dollar will report revenue of $2.62 billion. This will represent a 2% improvement compared to the $2.57 billion management reported for the same quarter last year but can't come anywhere near what Mr. Market is anticipating for Dollar General. For the current quarter ending in July, analysts believe Dollar General will see its sales jump 9% from $4.39 billion to $4.77 billion as higher comparable-store sales and an increased store count positively impact the retailer.

  Forecasted Last Year's
Revenue $2.62 billion $2.57 billion
Earnings per Share $0.89 $1.05

Source: Family Dollar

From an earnings standpoint, the situation looks even direr. For the quarter, analysts expect Family Dollar to report earnings per share of $0.89. This represents a 15% drop compared to the $1.05 per share management reported for the same period a year earlier and will result from soaring costs. To put this into perspective, Mr. Market believes Dollar General will see its rising sales accompanied by an 8% improvement in profit per share from $0.77 last year to $0.83 this year.

Foolish takeaway
Currently, there's not too much Icahn can do about Family Dollar. Although he is one of the company's largest shareholders, his ownership stake cannot hit 10% or greater because of a one-year shareholder rights plan put into place by the company's management that makes it nearly impossible to conduct a takeover. This means that he will have to win over the company's management team or other large shareholders if he insists on pursuing his plans any further.

Alternatively, if Family Dollar does pull off a miracle and significantly tops forecasts, it's possible that Icahn will change his approach to the business. But given its performance in recent years and its expected decline in profitability, this seems unlikely. For this reason alone, the Foolish investor should be cautious, but not necessarily pessimistic about the retailer. In the event that business improves, or if management becomes more receptive to some major changes, meaningful upside could await investors.