Family Dollar: A Good Long Term Investment
Ashish is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Last month, Family Dollar Stores (NYSE: FDO) hosted its first investor day since October 2010. The company’s stock price has declined 5.25% since its investor day while the S&P500 is up 4%. We believe much of this disappointment stemmed from management’s lack of clarity on near-term trends. While the bear case is focused on near term operational headwinds including consumables mix shift, discretionary weakness, and tough same store sales (SSS) comparisons in 2H; we are encouraged by the company’s potential to grow its store base 5-7% annually which is one of the fastest in hard-line retail, EBIT margin opportunity given SG&A reduction (as the company stands 300-400 bps above Dollar General (NYSE: DG) on a normalized basis), and gross margin expansion over time. We continue to believe that value retailers, including Family Dollar, can generate mid-single digit SSS growth despite a weak economy. The following are the key positives in favour of Family Dollar.
Significant Room to Expand
We expect 5%-7% annual footage growth for a number of years to come and believe the company has potential to at least double its store count over time. Recently opened stores in California are performing well, and we believe that state alone could represent more than 1,000 store incremental opportunity. Company’s new store productivity (at 85%-90%) is among the highest in retail, and a 1.5 year payback period is among the shortest.
Opportunity to Gain Wallet Share
Food is the biggest traffic driver; followed by household chemicals and paper, HBA, and tobacco. While FDO is gaining share in food and HBA, the growth has been primarily driven by higher spending per trip vs. growth in the number of trips. Family Dollar currently captures only $84 of its core customer's $6,000 wallet (1.4% share of wallet), and customers make just 6.4 trips to Family Dollar stores per year, out of 183 total trips. Thus, adding more traffic-driving items to the store, such as national brands in food/HBA, tobacco, and coolers, offers a good opportunity to drive SSS growth. It also seems likely that the company is evaluating adding healthcare services to stores, including pharmacies and retail clinics.
Margin Expansion Initiatives
The company plans to achieve higher margins through Global Sourcing Opportunities and by increasing their private branding portfolio. In addition, the company is testing zone pricing today with shrink improvement and reduced stem miles serving as incremental tailwinds. Looking forward, given the acceleration of key margin drivers, we believe low-double-digit EBIT margin is achievable (vs. 7.5% today) as compared to Dollar General’s 10.3%.
Success with Tobacco Rollout
While there were some concerns over Family Dollar’s tobacco strategy like lower gross margin and potential deterrent to families, the results thus far appear successful. The roll-out of cigarettes has improved the average ticket size. For instance, roughly 60% of cigarette buyers have purchased at least one other item in their transaction, leading to an average ticket size of $17. The company also indicated that beer and wine may also be added to stores in the future.
We continue to believe that the combination of value and convenience provided by all of the dollar stores, including Family Dollar, remains a highly compelling proposition for U.S. consumers. Moreover, the significant improvements made to store appearance and overall shopping experience in recent years should augment these advantages.
Family Dollar is trading at a 10% discount to Dollar Tree (NASDAQ: DLTR), despite having better growth prospects. As per consensus estimates, Family Dollar’s is expected to post a 15.9% EPS growth next year, which is higher than Dollar Tree’s 14.34%. Dollar Tree is also facing a stiff competition from Dollar General and is running a danger of losing some market share. Family Dollar’s increasing focus on $1 items can also cause a concern to Dollar Tree. Family Dollar is also the only dividend (dividend yield=1.3%) providing company among these dollar stores.
While Family Dollar’s near-term results may turn out to be a bit irregular given the many initiatives and investments that the company is simultaneously making to improve its business, we believe the long-term growth profile remains attractive. We recommend it as a good long term investment.
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