This Earnings Surprise Might Turn Out to be a Shock

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After the announcement of positive third-quarter results, Family Dollar Stores (NYSE: FDO) share price rose 7% the very same day. However, investors failed to observe the results closely, thus they didn’t realize that falling profits and declining margins are not very good signs for the company.

The company took a major beating in January after its results for the first quarter were published as it trimmed its whole year's guidance and since then, it has narrowed its guidance further in every earnings.
Family Dollar reported an impressive 9% increase in revenue compared to the same period last year, which was primarily because of a 2.9% growth in same-store sale and the 129 new stores that it opened in the last quarter. Revenue improved mainly because of an increase in sales of consumables, like tobacco and food items, without any increase in the sale of its discretionary products. This is evident from the fact that consumables sales now form 72.5% of its revenue, up from 69% last year.

The low and middle-income population generally shops at discount stores and they continue to remain under pressure because of increased payroll tax, delays in getting tax refunds, and other economic troubles. So the consumers will focus their attention on necessities, which would eventually increase consumables sales in the future too. This will further deter its margins and profitability.

Family Dollar's operating margins have been declining over time, as the sales mix has shifted more towards lower-margin consumables and currently stands at 6.95%, which is the lowest compared to its peers. Sales will probably increase in the future, but falling margins and narrowing its guidance every quarter is working negatively for Family Dollar Stores.

How are other dollar stores holding up?

Dollar General (NYSE: DG), the largest of the dollar stores with over 10,500 stores, is fairly better positioned than its competitor Family Dollar. Dollar General shares have appreciated more than 25% this year and it has been able to maintain its margin at a decent 10.20%.

Dollar General has been growing well, too. Its comp sales have grown 3% and further, it has opened 165 new stores in the first quarter. The company plans to open a total of 635 new stores this year. In order to attract customers and combat competition, Dollar General slashed prices of its merchandise, which has affected its margins. This has shifted its sales more towards lower margin goods in consumables as well as discretionary, which is a sign of concern.

Saving the best for the end

Dollar Tree (NASDAQ: DLTR) is the smallest among dollar stores, but still a major threat to both Dollar General and Family Dollar. Dollar Tree, in the true sense of the word, is a dollar store, as it’s the only store among the three that offer goods at $1. This single price strategy has worked well in the company’s favor and that is the reason it has registered decent growth and raised its guidance for the year.

The company, unlike its competitors, has not resorted to selling low margin consumables or tobacco to increase its foot fall and thus it enjoys a margin of 12.59%. On the other hand, Dollar Tree assertively installed freezers and coolers in its stores, which acted a catalyst for improving the average ticket size. it is continuing to do so to increase its revenue while holding its margins.

It has also focused on increasing its store count and improved its square footage by 7.7% last year and intends to continue its efforts this year by adding 7.3% square footage further. 

Dollar Tree's growth initiatives are going strong, which should yield return in the future. Moreover, strategic merchandise offering and arranging goods tactfully has helped the company achieve the highest average new store sales per square foot in the industry in the last fiscal year.

Take away

In terms of performance and returns, Dollar Tree is the strongest of the lot and looks very promising for the future. Dollar General has also performed decently till the first half of this year and should be of good value for its investors if it can maintain its margins. I believe Family Dollar Stores is the weakest among all dollar stores even though it has shown decent growth in revenue, but its declining margins make me hesitant about investing in it.

pranay agrawal 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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