Foolish Forecast: Flexing Family Dollar

How far can you stretch a dollar? The answer varies from person to person, but the more people who try, the better business gets for Motley Fool Stock Advisor recommendation Family Dollar (NYSE:FDO). For an update on the nation's economy in miniature, we'll hear from the company on its fiscal Q3 2006 earnings tomorrow morning.

What analysts say:

• Buy, sell, or waffle? Eighteen analysts now follow Family Dollar, one more than three months ago. The ratings comprise six buys, 10 holds, and a pair of sells.
• Revenues. The analysts expect Family Dollar to report 10% more sales tomorrow than it did a year ago. $1.6 billion is the target.
• Earnings. Analysts expect these to grow 9%, to $0.35 per share.

What management says:
On June 1, Family Dollar reported its sales numbers for the month of May, the third quarter, and the year to date. The news was mixed. The bad news was that Family Dollar came in just shy of analyst estimates for the quarter with 9.9% sales growth. The good news is that the trend looks optimistic. Year to date, the company has grown its sales 9.6% in comparison to the first three quarters of last year. Thus, the 30-basis-point improvement in the third quarter shows sales accelerating as the year progresses. Finally, the May number was 10.7%, suggesting further acceleration.

The trend in same-store sales bodes similarly well: 3.3% year to date giving way to 3.7% growth in the third quarter, and 4.5% in May.

What management does:
Margins are heading the other way, however. On a rolling basis, gross margins are holding up pretty well -- down just 20 basis points from one year ago. However, operating costs (read, essentially, "fuel costs") are outstripping sales growth and compressing operating and net margins. Over the last six months, Family Dollar's operating costs rose 12% against sales growth of less than 10%, both in comparison to last year. Adding insult to injury, the firm had to record a $45 million charge to earnings to cover damages it may have to pay as a result of a lawsuit for failure to pay overtime to managerial employees, further depressing the company's net.

One Fool says:
Ordinarily, in this section of a Foolish Forecast for a company that we've recommended, I'd give you a glimpse at the recommending analyst's most recent thoughts on the company. Today, however, I'm in a bind. Stock Advisor co-analyst Tom Gardner, who recommended the stock last year, recently updated his valuations on all the companies he's recommended for our subscribers. Problem is, he did this just one month ago, and publishing the details of his analysis so quickly wouldn't be fair to our paying subscribers.

But I can share with you what Tom had to say about Family Dollar back in December: "The investment thesis here is still to buy retail when it is deeply out of favor, which is certainly true for discount retailers in general, and Family Dollar in particular." That thesis has a once and future ring to me. At Stock Advisor, retail peer Pacific Sunwear (NASDAQ:PSUN) and, over at our sister publication, Motley FoolHidden Gems, retailer New York& Co. (NYSE:NWY) continue to be shunned by the market -- one reason Tom and our other analysts have been loading up on them. Like these two, Family Dollar's doldrums won't last forever. The time to buy just might be now, when things still look bleak.

Or not. For an opposing view on Family Dollar's value, read Seth Jayson's Family Dollar Not So Cheap.

Competitors:

• 99 Cents Only (NYSE:NDN)
• Dollar Tree (NASDAQ:DLTR)
• Dollar General (NYSE:DG)
• Wal-Mart (NYSE:WMT)

Dollar Tree and Wal-Mart are Motley Fool Inside Value recommendations. Take the newsletter dedicated to top-shelf stocks at bargain-basement prices for a 30-day free trial.

New York & Co. is a Hidden Gems pick.

Fool contributor Rich Smith does not own shares of either company named above.