Jim Cramer is Wrong About These Two Dollar Stores

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The dollar stores in the United States have seen great success since the recession hit in 2008.  Many consumers have scaled down their spending as a result of painfully high unemployment and stagnant wages.  Two of the companies that operate in the deep discount retail space are Family Dollar (NYSE: FDO), a $7 billion business, and Dollar General (NYSE: DG), a $14 billion company.  These stores operate chains of self-service retail discount stores primarily for low- and middle-income consumers in the United States.

On Jan. 16, Jim Cramer provided investors with a sell recommendation on both Family Dollar and Dollar General.  He gave the following reasons for his negative view on the two companies:  the stocks have been posting disappointing numbers, causing their share prices to decline over the last few months, and the end of the payroll tax holiday would hurt the low-end retailers.  The problem with these arguments is that they are largely anecdotal.

First, with respect to the ‘disappointing’ earnings from the dollar stores, we need to analyze the numbers before making that kind of a judgment.  Financial performance, like beauty, is in the eye of the beholder.  Cramer pointed to the drop in Dollar General’s margins as a reason to sell the stock.  While it’s true that the company’s margins suffered slightly, the overall operating performance of the company was extremely solid.  In December, Dollar General reported third-quarter earnings of 62 cents per share, a 24% increase over the prior year’s third quarter.  For the first nine months of the year, Dollar General’s net revenues and earnings per share grew 11% and 37%, respectively.

Likewise, Family Dollar had a successful start to 2012.  Third quarter net sales and earnings per share increased 12.7% and 1.4%, respectively.  What especially troubled Cramer about Family Dollar was that it brought down its fiscal 2013 profit guidance to a range of $3.95-$4.20 per share from a previous range of $4.10-$4.40 per share.  While nobody likes to see a company lower its earnings forecast, even if we assume next year’s earnings to be $3.95 (the lowest point of the range), an investor is paying only 14.5 times forward earnings.  Moreover, on Jan. 17, the company increased its dividend by more than 23% and authorized a new $300 million share buyback program.  This marked the 37th consecutive annual dividend increase for Family Dollar.

Curiously, Cramer noted the end of the payroll tax cut and therefore directed investors to consider buying stock in Five Below (NASDAQ: FIVE), a store where every item is (you guessed it) five dollars or less.  I frankly don’t understand the argument that a small hike in the payroll tax will cause material harm to the dollar stores’ businesses.  In fact, if more consumers felt the need to scale down their spending habits because of higher taxes, that would cause business for the dollar stores to grow, not contract.  Also, I fail to see how this issue would harm Dollar General and Family Dollar, but not hurt Five Below as well. 

Moreover, Five Below hasn’t been performing well over the last year.  During the first nine months of 2012, net income dropped to $819,000 from $3.6 million from the same period in 2011.  Five Below reported a net loss of $2.21 per share over the first three quarters of 2012.  Furthermore, the company’s balance sheet deteriorated last year, nearly tripling its long term debt from January to October 2012.

Cramer said that because the share prices have declined, Dollar General and Family Dollar should now be sold.  In my opinion, it’s extremely foolish (with a lowercase 'f') to sell a stock based on share price movements alone.  Family Dollar has seen its stock fall from $71 at the beginning of December to its current level of $58, a decline of more than 18%.  Likewise, Dollar General’s shares have also declined 18% from their 2012 high.  Clearly, no investor likes to see the value of their investment go down.  But the combination of improving fundamentals and a declining share price is an opportunity for investors to profit from the market’s irrationality.  Plainly stated, I believe that Cramer is wrong about Family Dollar and Dollar General.

rciura 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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