Dividend Aristocrat With Real Dollar Problems

By Chad Henage - July 10, 2012 | Tickers: DG, DLTR, FDO | 0 Comments

• Email
• Print

Generally speaking, I've been impressed with the growth in dollar retailers. However, there is a disturbing trend I've noticed with one company in this field. Even more disconcerting is this company is a dividend aristocrat. The company we are talking about is Family Dollar Stores (NYSE: FDO). The company has increased its dividend for more than 25 straight years, but this streak will be in jeopardy unless the company makes some changes. 

On the surface, Family Dollar Stores appears to be just as attractive of an option as its competition. Competitors like Dollar General (NYSE: DG) or the privately held Five Below, offer a similar pricing structure, where everything is priced at an even dollar price point. In the same field, but offering a single price point, are companies like Dollar Tree (NASDAQ: DLTR) and the now private 99 Cents Only stores. When you consider that Dollar General is expected to grow earnings by over 18% in the next few years, and Dollar Tree is expected to show growth of almost 18%, you can see this is a growing industry. Family Dollar is expected to show EPS growth of just over 14% itself. With three different publicly traded companies, all expected to show growth in the teens, it's clear that consumers are finding value in this dollar pricing strategy. There is a difference behind the scenes at Family Dollar that is a concern though.

To show you my concern, take a look at three different growth rates at Family Dollar and you tell me if this looks fine to you:

(in millions except 3 yr growth) 

I see the same problem that should jump off the page at everyone else. Capital expenditures are growing at a faster pace than either net income or operating cash flow. While some would say, it doesn't matter because the company is going to do better in the future, I would suggest investors look at the company's cash flow statement for the last two quarters. Even if you strip out other items, and just look at net income and depreciation versus capital expenditures, the picture isn't getting much better. In November 2011, the company generated $129.49 million in net income and depreciation and spent $130.86 million in capital expenditures. This is part of why the company was forced to borrow funds to cover their dividend during the quarter. The February 2012 quarter shows a similar, but less dire pattern. In this quarter, the company generated $187.241 million in net income and depreciation, and spent $105.4 million in capital expenditures. If this seems fine, consider the quarter's dividends used $21.2 million of the remainder which left just $61 million in actual free cash after dividends in the last two quarters.

The point is, the company is spending a large chunk of their operating cash flow on capital expenditures each quarter. This challenge is beginning to show up in the company's balance sheet. In the last four quarters, Family Dollar's cash and investments have shrunk by $211 million, while total liabilities have risen slightly. While the company is not in imminent financial danger, this is a trend that bears watching.

Another trend that is tied to both cash flow, and the balance sheet, is the company's dividend. In the last three years, the company's free cash flow payout ratio has risen from under 20% to over 45%. While part of this has to do with larger increases in the dividend, clearly the company can't continue this rate of increase in their payout ratio. The recent pace of dividend growth has a lot to do with why the company's payout ratio has risen recently, so let's look at what's been going on with dividend growth next.

In the last several years, the company has gone through two distinct cycles of dividend growth. Look at the trend over the last eleven years:

From 2003 to 2009, the company slowed down its dividend growth each year sequentially. Then from 2010 to 2012, the company sped up its dividend growth. The strange part is, during the most recent three years when dividend growth jumped significantly, operating cash flow was flat. This should argue that the company expects better growth in the future, but the numbers just don't point in that direction.

In fact, with analysts expecting growth of about 14%, I would usually suggest that a 45% payout ratio means dividend growth of around 14%. I fear that won't be the case with Family Dollar going forward. In the last multiple years, net income growth has not equaled operating cash flow growth. Unless cash flow grows, large dividend increases will be limited in scope. In addition, with capital expenditures significantly outpacing even net income growth, the company has to make a choice: huge capital expenditure growth, or the dividend. I would suggest investors play Family Dollar very cautiously. In my estimation, the best case scenario is dividend growth of 8-10% as the company figures out how to maintain dividend growth, while slowing down capital expenditures. The worse case scenario is the company continues to grow capital expenditures by a large amount, while dividend growth has to slow down significantly to accommodate this bigger commitment to expansion. The absolute worst thing that could happen is the company loses its dividend aristocrat status, because they are too aggressive expanding the company.

• Email
• Print
• Feedback