Is This Retailer the Next Wal-Mart or an Aberration?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

No retailer has attracted more attention in the last year or so than Family Dollar Stores (NYSE: FDO). It is easy to see why. If you drive around America these days, there seems to be a Family Dollar in every shopping center and small town main street.

Family Dollar opened 475 new stores in the past year and entered the California market for the first time. The new stores seem to have helped Family Dollar as its fourth quarter sales of its 2011-2012 fiscal year were 10.8% higher than in the same quarter of the last fiscal year. Total sales at Family Dollar were $2.36 billion for the quarter.


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Mr. Market obviously likes these numbers; he has rewarded Family Dollar with an earnings multiple (18.56) that is higher than both Wal-Mart's (NYSE: WMT) 16.13 and Target’s (NYSE: TGT) 4.44. The market seems to think that Family Dollar is a serious rival to these retailer goliaths, but is the market right?

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Family Dollar currently has a market cap of $7.776 billion compared to Wal-Mart, which has a market cap of $253.80 billion. (AMZN), which even Wal-Mart now regards as a serious competitor, has a market cap of $109.51 billion. Target has a market cap of $40.68 billion. So Family Dollar has a long way to go before it enters the same club as Wal-Mart and Target. The truth is that Family Dollar isn’t even in the same category as Costco Wholesale (NASDAQ: COST), which has a market cap of $42.17 billion.

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Naturally, many investors will wonder if Family Dollar is over-valued. It is trading at a higher price than Target, a company that had sales of $71.34 billion and income of $2.94 billion at the last count. Yet Family Dollar had sales of just $9.33 billion and income of $422.24 million. Even if Family Dollar posts sales growth of 10% a quarter, it’ll take five to ten years to overtake Target, let alone Wal-Mart. Family Dollar will have to work to keep up with Charlie Munger’s favorite, Costco; the discount club had sales of $99.14 billion and an income of $1.71 billion.

Call me a cynic here, but it looks like Family Dollar is overpriced when you start crunching the numbers. It looks like a classic case of hype rather than actual cash moving share values. The best advice for value hunters at this time is to stay away from Family Dollar; it has moved out of value country and into the world of hyped-up media and analyst darling.

This doesn’t mean Family Dollar is a bad company; it just means that the market is paying too much for it right now. In the last year, Family Dollar sold $6.4 billion worth of consumables, which was up 13.2%. Yes, Family Dollar has posted an impressive level of sales and income growth, 9.2% and 8.7%, but it isn’t the best retailer on that score. Costco’s sales and income growth numbers were actually higher than Family Dollar’s. Costco’s sales grew by 11.5%, and its income grew by 16.9%.


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So if there is a big success story in discount retail right now, it is Costco, which is being ignored, even though the market seems to be paying a lot of attention to it. As so often happens, the market pays more attention to physical growth, such as the frantic opening of new stores, which generates a lot of news stories, rather than actual cash being generated.

Costco also seems like a bigger threat to Wal-Mart and Target than Family Dollar does. Most of Family Dollar’s growth has been at the expense of drugstores like Walgreen (WAL) and smaller regional retailers like Fred’s (FRED) rather than the big retailers. Family Dollar is, after all, something of a bottom feeder, going after lower income customers in rural areas and the inner city. Costco’s strategy of going after the middle class is generating better numbers. It doesn’t seem to target the middle class, and it deliberately avoids a lot of sectors, such as most groceries and pharmacies.

Family Dollar is yet another reason why you need to take a look at the numbers rather than the media hype. The hype machine would have us believe that Family Dollar is in the same league as Wal-Mart, Target, and Costco. The numbers tell a very different story. Family Dollar is overvalued, and it is never likely to be as big a retailer as Target or Costco, let alone Wal-Mart.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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