Product Mix is Holding This Retailer Back

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

Family Dollar Stores' (NYSE: FDO) stock price has increased by 7.5% in the last three months, but the story is different if we look at the last 12 months. Its stock price has declined by 0.11% and 4.72% in the last six months and one-year period, respectively.

The company has taken initiatives for strong growth with increased selling space this year through new store openings and store remodeling. Its comps growth was driven by the consumables category last quarter, but margins are under pressure due to the weak performance in the discretionary category.

It has taken initiatives in store expansion for growth and direct sourcing of products with supply chain partnerships for improving margins, but its product sales mix (consumables versus discretionary) is expected to be a headwind for the company. Now, let’s discuss these points in detail.

Store growth with Fee Development Program are expected to drive growth

In the second quarter, Family Dollar opened 126 stores and has plans to open a total of 450-500 stores this fiscal year. Its Fee Development Program will enable it to develop stores with a better financing model. In this program, the company will develop the stores and then sell or lease them to third parties. The cash generated will be used to construct new stores. It has sold 127 stores in the first half of the year and achieved gain of $73.2 million on these transactions. Its store growth along with remodeling will increase its selling space by 6% this year.

Direct sourcing and private labels are expected to help margins

The company has taken initiatives to increase its direct sourcing of products and entered into supply chain relationships. It entered into 25-30 supply chain partnerships in 2012 and around 75-80 partnerships are in the pipeline. It opened its fourth direct sourcing office in Bangkok this year.

Its direct sourcing initiatives will help it to charge higher markups and achieve margin benefits. It will add 400 private label SKUs in the second half of this fiscal year which are relatively high margin products. These initiatives will help its margins to some extent.

But weak discretionary sales is expected to be a headwind 

The company's gross margin performance in the last quarter was 146 basis points lower than the same period last year. Its weak performance was due to the higher sales mix of low margin consumables category.

Its consumables mix in sales has increased from 64.6% in the second quarter of 2012 to 69.5% in the second quarter this year. Its consumables sales increased 26% but discretionary segment sales were weak. Home segment sales declined 1.4% last quarter and Apparel increased by just 0.46% compared to the same period last year. Consumables sales will drive comps growth but discretionary categories will remain under pressure in future.

Peer analysis

In the Dollar Stores segment, the other two players that are competitors of the Family Dollar Stores are Dollar General (NYSE: DG) and Dollar Tree (NASDAQ: DLTR).

Dollar General is the largest Dollar Stores chain and it is still expanding its store base. It has plans to open 636 new stores in this fiscal year along with the remodeling of 550 stores. It will increase the number of coolers and freezers in its new format stores, DG Plus and DG Market. Additionally, it will rollout tobacco across its entire stores chain by the end of the second quarter. Its Phase 5 merchandising initiatives with new planograms and SKUs have been expanded to 4200 stores, and it is expected to drive sales growth for the company.

Dollar Tree is also increasing its store count in the US and Canada and will look for 7-8% square footage growth this year. It will open 320 new stores and remodel 75 stores this fiscal year. It has also increased the number of coolers from 475 to 550 in its stores during fiscal 2013. Its master card rollout across the chain will increase sales growth at its direct channel, Dollar Tree Direct. It has increased impulsive buying items by 40% and introduced new front end fixtures with more selling space. All these initiatives are expected to drive sales growth for it in future.

 

P/S ratio

Op. Margin

1Yr. Fwd. P/E

Family Dollar Store

0.68

7.50%

15.08

Dollar General

1.01

9.33%

14.13

Dollar Tree

1.54

11.61%

15.79

Source: Google Finance

Family Dollar Store reported an operating margin of 7.50% last quarter and the lowest P/S ratio (0.68) among the three mentioned peers. Dollar general has an operating margin of 9.33% and the lowest one-year forward P/E among its peers. Dollar Tree has the highest operating margin of 11.61%, but also the highest forward P/E of 15.79.

Conclusion

Family Dollar Stores is investing in new stores growth and remodeling the existing ones to increase selling space this year. It has taken initiatives for margin growth this year with increased supply chain partnerships for direct sourcing. It will add 400 new private label SKUs with relatively high margin product categories. However, high mix of consumables is expected to be a headwind for the company's gross margins and hence I remain neutral of the stock.

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Ash Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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