Earnings Preview: Family Dollar Stores

tarun 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) has had a bad run up until now, as its stock price has remained almost flat from where it started at the beginning of the year. A lot depends on whether the company’s upcoming third-quarter results, due out on July 9, provide the much-required momentum. Will the bad phase continue or will there be some relief for the investors? Let’s find out.

About revenue

According to analysts at Yahoo! Finance, Family Dollar is expected to post revenue of $2.57 billion, which, if achieved, would be a growth of 8.9% compared to a year-ago period. The company has predicted a full-year increase in sales by 12%-13%, which shouldn't be very difficult to achieve.

Family Dollar has been slashing its revenue estimate in its last two earnings releases. Thus, as revenue estimates are being adjusted a bit lower, as per Family Dollar’s comfort range, the company should easily achieve the target.

About earnings

Though the top line is expected to be about 9% higher than last year, the bottom line is expected to be 3% lower than the same period last year, and is expected to be $1.03 per share. However, this estimate sits right at the mid-point of the company’s own guidance of $0.98-$1.08 per share.

 Let's analyze the company’s past year's reported earnings.

     
 

Quarter ended

Estimated Earnings

Actual Earnings

Surprises

 
 

May 2012

1.07

1.06

-1%

 

Aug 2012

0.75

0.75

0%

 

Nov 2012

0.75

0.69

-8%

 

Feb 2013

1.22

1.21

-1%

The past isn't an assurance about what the future might turn out to be, but it does give us a rough idea of what to expect. However, in the last four quarters, Family Dollar has missed achieving analysts' revised earnings estimates. Moving forward, if the trend is expected to continue, the company’s earnings, at best, can meet the consensus estimate of $1.03.

Over the last 90 days, the EPS estimate has been adjusted from $1.18 per share to $1.03 per share, but as the company’s management expects the margins to improve, they should not find it difficult to achieve the estimated bottom line.

With every quarter, as the company releases its earnings, it slashes its guidance for the full year to account for its inability to achieve its previous quarterly results. In its 4Q12 earnings call, the company gave its earning guidance for fiscal 2012 as $4.10-$4.40 per share, but in its last earnings call it reduced its whole year guidance to $3.73-$3.93 per share. This is approximately a 10% reduction from its first guidance six months ago. I believe this trend is only withering investor confidence in the company.

More troubles

Family Dollar has achieved slight growth in its comparable sales, but its gross margins have been falling. The company found itself in a difficult spot when it tried to expand its non-consumables sales, but actually failed to sell higher margin products to its customers. The company did achieve some growth in revenue, but that was in lower margin products that are currently affecting its margins.

Family Dollar has a very high inventory level, which it has been unable to convert into sales. If sales tend to slow down, the company might find itself in troubled waters. Further, it has an extremely low quick ratio of 0.30 times. The company presently has $189 million in cash and cash equivalents, while payables as of March 2013 were over $1 billion. Family Dollar’s short-term debt has increased more than 10 times in the last three quarters, signifying that it may possibly be struggling to pay short-term obligations.

Competition

Dollar General (NYSE: DG) and Dollar Tree’s (NASDAQ: DLTR) stocks have gained 20% and 30%, respectively, since January 2013. Dollar General, with 10,600 stores and a market capitalization of $16.73 billion, is the biggest among the dollar stores. The stock is performing exquisitely, despite disappointing first-quarter results that depreciated the share price, which I believe only made shares more attractive for investors.

The only concern regarding Dollar General is its shrinking margins, as it’s mainly being able to sell only those goods that carry lower margins. Moving forward, if the company can strike a balance in its sales mix and generate more sales from non-consumables, which carry high margins compared to consumables, then it will be in a win-win situation.

In order to keep investors happy, the company returns a lot of cash in the form of share repurchases and dividends. Year-to-date, Dollar General has repurchased approximately $220 million of its common stock, and since the inception of the repurchase program in December 2011, it has bought back approximately $1.1 billion of its shares.

Dollar Tree, the smallest player among dollar stores with around 4,700 stores, has lead the year so far with an exemplary performance. The company’s methodical strategy and concrete implementation by management have helped it maintain a lead over its peers.

The main driver of the company’s success is its wholehearted focus on offering merchandise at a single price of $1. Moreover, being the smallest among the three gives it more opportunity to expand, keeping its focus on store productivity and coverage. Dollar Tree Direct, its e-commerce platform, is also growing at a good pace, with 23% increase in traffic compared to previous quarter.

Final words

Family Dollar is currently the weakling among the three companies, as cutting its own guidance every quarter is deterring investors’ faith and raising eyebrows about how well management is able to run the company. Further, the increase in debt load is only making things worse. Dollar General and Dollar Tree, on the other hand, have been generating sound returns and should continue to do so in the future.

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tarun bachhawat 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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