Consider this Stock to Profit from the Patchy Economic Recovery

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Last month, I discussed discount retailers and told you why they are the go-to stocks when the economy is not in the best of health. In that post, we saw that Dollar General (NYSE: DG) is the best placed discount retailer to benefit from the present economic conundrum, driven by its huge store presence and expansionary measures that are helping it win market share.

But, I had also said that peer Family Dollar Stores (NYSE: FDO) seems to be the best bet after Dollar General, largely due to its 7,000-plus stores and partnership with Coinstar (NASDAQ: OUTR) for placing Redbox kiosks at its stores. However, Family Dollar had failed to put up decent numbers and a decent outlook in the third quarter, sending shares down.

An Improved Performance

As such, an improved showing in the recently reported fourth quarter came as a much needed shot in the arm for Family Dollar, and the stock gained almost 4% after earnings. The company met estimates this time and guided just ahead of analysts’ earnings expectations for fiscal 2013. More importantly, the company grew its same-store sales 5.4% in the quarter from last year, primarily driven by a 16% jump in sales of consumable items.

The company was aided by cautious consumers who were in the hunt for value deals. Family Dollar is a frequent stop for the low and middle income strata of the society and it has been quite successful in bringing those customers to its stores. Moreover, Family Dollar’s expansion of its consumables offerings helped the company rake in more revenue despite a soft beginning to the quarter.

Expanding in Different Ways

Family Dollar is focused on improving its presence and it is expanding its store count at a great pace. The company opened 175 net new stores as against 80 in the same quarter last year. Moreover, Family Dollar intends to open around 500 new stores this fiscal year while closing around 70 to 90 stores.

Apart from store expansion, Family Dollar is also focused on improving the offerings in its stores. It added around 600 stock-keeping units in its health, beauty and personal care segments last fiscal and about 400 stock-keeping units in the food segment, and also started selling tobacco products in May.

Moreover, Family Dollar’s deal with Coinstar for placing Redbox kiosks at its stores is another positive. Redbox is a fast and reasonable method of getting the latest movies on rent and this has added to Family Dollar’s array of offerings, along with giving Coinstar more locations to place its Redbox kiosks. According to analysts, the deal with Redbox can contribute another 15 cents to Family Dollar’s bottom line if the kiosks are placed at 80% of its stores.

Short-Term Margin Pressure, but Should Get Better

However, Family Dollar does expect its margins to remain under pressure in the beginning of the new fiscal year as sales of its new additions, particularly tobacco and food products, increase. These low-margin products would keep gross margins under pressure initially but the company expects the pressure to ease once its pricing and sourcing strategies take effect.

Family Dollar is also making efforts to improve its supply chain and opened its 10th distribution center (DC) that services 600 stores in Ashley, Indiana, in the previous quarter. The work on the 11th distribution center has already started in St. George, Utah, and it is scheduled to start operations in the summer of next year. These DCs should strengthen the supply chain and also help bring down costs in the long run for Family Dollar, helping margins further in the process.

The Takeaway

Family Dollar has been delivering decent top-line and bottom-line growth over the past several quarters and expects the trend to continue going forward. With a sluggish economic recovery still a cause for concern, I expect more consumers to flock to dollar stores in order to save their bucks.

Family Dollar seems to be making the right moves to get these consumers to its stores by offering more merchandise and increasing its store count. Margin pressure might be a concern but the company expects to iron out the problem over the course of this fiscal year. The stock has already appreciated about 19% this year and, in my opinion, it can get even better over the long run. 

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