Family Dollar Treads Water While Retail Changes

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

Dollar retailers have been hit hard by the tough economic environment in which consumers are cutting back on spending. Moreover, the cold spring weather is also not helping. Family Dollar Stores (NYSE: FDO) is now looking toward unattractive lower-margin goods to provide a much-needed boost to sales while it waits for the economy to turn around.

The second-largest U.S. dollar-store retailer Family Dollar Stores' fiscal second-quarter earnings increased 2.7% due to higher revenue; however, profits missed estimates, which the firm believes was caused by a delay in its customers getting their tax refunds.

Same-store sales rose by 2.9% versus the company's internal forecast of 4% to 5%. Sales were strongest in consumables, which increased 26.6% during the quarter, mainly due to strong growth in tobacco, food, and health and beauty products.

Family Dollar anticipates that sales of discretionary items, such as apparel and home goods, will continue to decline for the rest of its fiscal year. In its most recent quarter, net sales of apparel and accessories rose only 0.5% while home product sale were down by 1.4%.

Competition

Family Dollar, whose main competitors include Dollar General (NYSE: DG) and Dollar Tree, recorded a 17.7% increase in net sales to approximately $2.9 billion. Net income rose to $140.1 million, or $1.21 per share, up from $136.4 million, or $1.15 per share, a year earlier.

Family Dollar’s weaker-than-expected second-quarter results were partly caused by a delay in tax refunds, which impacted sales at the end of January and in early February. However, revenue was inline with analysts’ estimates, so that argument rings hollow.

During the quarter, the company opened 126 new locations and closed 17 old stores. Dollar General, which operates thousands of more stores and generated $16 billion in revenue in its previous fiscal year, posted better-than-expected quarterly profit last month.

A shift to lower margin items is what drove the slight miss in earnings. In recent months, Family Dollar started to focus on selling high-turnover merchandise, such as cigarettes and other tobacco products, soft drinks, magazines, gift cards etc. These items bring shoppers in stores more frequently but carry lower margins than other merchandise, such as apparel.

Dollar General has also made a similar move and is focusing more on food products. However, while Dollar General has still been able to increase its net profit margin from 7% to 7.5% year-over-year, Family Dollar’s has fallen from 5.6% to 4.8% in Q2 2013.

This is a fiercely competitive industry where dollar stores are not only fighting off each other but also the brick-and-mortar behemoth Wal-Mart Stores (NYSE: WMT) – which isn’t doing that great either, for similar reasons – as well as the king of the online world Amazon.com, which deliveries groceries to doorsteps as efficiently as books. In this environment, Family Dollar has had to consistently increase its capital expenditure plans – rising from $600 million to $650 million to a range of $650 million to $700 million for the current year.

Wal-Mart is struggling with its huge store footprints and has seen its market share siphoned off in rural areas by the rise of the dollar store. And that problem is only going to get worse with persistently high gasoline prices, which raise the value proposition for local retailers versus the larger, more-centrally located ones.

The consumer

Consumer attitudes toward discretionary spending are turning out to be a major challenge for the company. In January, Family Dollar announced the approval of a $300 million share-repurchase program. This comes in the midst of Family Dollar's recent share price struggles, which is a good value play for a low-growth and high cash-generating business to support the share price.

A long-term goal of 5% to 7% growth in square footage is still in play for Family Dollar’s management, which remains committed to opening 500 new stores in FY13. Family Dollar has now given an annual earnings estimate of $3.73 to $3.93 per share.

Similarly, for the current quarter, the business is expecting to net earnings between $0.98 and $1.08 per share. Analysts were expecting $1.18, which further underscores this point. On the other hand, Dollar General, which has easily outperformed its smaller rival, has given an annual earnings guidance of $3.15 to $3.30 per share, which is inline with analysts’ estimates of $3.27 per share.

However, investors should remain wary of dollar-store stocks, due to these changes in the market, which incidentally should accelerate as 2013 grinds along. Softening commodity prices are signaling a difficult second half and with increased marginal taxes thanks to the fiscal cliff settlement the current trends in consumer discretionary behavior are likely to continue into 2014.

The dollar store model, however, will continue to evolve as retail downsizes, becomes more regional and focused on items that cannot be cross-shopped online.


Peter Pham has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. 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!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure