99 Cents Only: Check the Bargain Bin

Earnings looked a little cheap at 99 Cents Only Stores (NYSE:NDN), but the reaction they got certainly wasn't warranted. As of about lunchtime on Friday, the stock market had taken, interestingly enough, 99 cents off the company's stock price.

What has investors rushing for the exits? Perhaps it was that an income-tax benefit boosted bottom-line results this quarter, compared with an expense last year. As a result, the company earned $0.04 per share, versus $0.03 a year ago.

However, there were strong fundamentals to take comfort in. For starters, same-store sales rose a solid 5.2%, for the seventh consecutive quarter of comps increases. Other competitors aren't doing as well on this front: For the same three months, Fred's (NASDAQ:FRED) fell 2.5% in April, rose 0.2% in May, and rose another 1.5% in June, while Family Dollar Stores (NYSE:FDO) has also struggled and recently lowered its outlook for the year.

Mom-and-Pop dollar stores have been going out of business in my area because of high rents and trouble getting inventory. That situation bodes well, however, for a large chain like 99 Cents Only Stores that has economies of scale.

Gross margins also increased, for the third straight quarter. And margins were 38.9%, a 100-basis-point expansion from the prior year. But as the company itself admits, it has work to do in reducing sales, general, and administrative expenditures, and doing so will become a major focus in the second half of the year. It will also emphasize improving merchandise flow and inventory management, enhancing labor productivity, and streamlining Sarbanes-Oxley compliance.

In considering this company, keep in mind that there's about $120 million in cash and short-term investments, and no long-term debt on the balance sheet -- excluding small capital lease obligations. That amounts to more than $1.70 per share, and it should help quell fears over the latest earnings news, since the company can now afford to invest in other initiatives.

Given the company's top-line strength and expanding gross margins, today's reaction may well be overblown. As costs are cut, investors may well look back and realize they should have put this stock in their carts.

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Family Dollar is a former Stock Advisor pick.