Family Dollar SWOT Analysis: Plenty of Opportunites

Victor is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When looking at outperforming retail segments, dollar stores usually appear on the list. Family Dollar (NYSE: FDO) comes across as quite an appealing investment opportunity. Family Dollar could be at an inflection point considering that it has new management with critical small box experience and is accelerating multiple initiatives that should yield strong earnings growth. However, as wise investors know, every major aspect of the company should be weighed before investing. With this purpose, we will look into the main strengths, weaknesses, opportunities and threats (SWOT) of Family Dollar Stores.

Strengths

  • Growing industry: Over the last few years, dollar stores have surprised retail giants with their simple but solid (and successful) business proposal: low operation costs, discount prices for the public (on average 20% lower than the prices offered by supermarkets), a targeted customer base, convenient locations and small-box format stores that provide an easier, less stressful shopping experience. While this business has not yet reached its ceiling, growth prospects make it an interesting choice for investors. As a result of this advantage, dollar stores have offered comparable store sales growth (approximately 5% on average since 2010) that is considerably higher than that of their competitors: supermarkets, drugstores and discounters saw under 3% growth, on average, for the same period.

Weaknesses

  • Economically sensitive client base: Payroll tax cuts implemented in January 2011 are always an issue when analyzing the success of dollar stores, since their competitiveness largely relies on this policy. Expected cuts to this incentive during 2013 could seriously diminish the company’s and the whole sector’s profits. Another important stimulus that could be cut back by the government in 2013 are food stamp plans for the unemployed or underemployed. Since this means of payment is used by 10%-15% of Family Dollar’s clients, a reduction in their circulation would certainly impact its sales.
  • Business suffers from higher oil prices: A correlation between dollar stores' sales and fuel prices seems to exist. Higher energy expenses cannot be transferred into prices since the sector’s competitiveness relies on their everyday low price strategy. In consequence, upsurges in the oil prices would definitely lower profit margins.

Opportunities

  • Expected growth: Dollar stores’ growth potential are still far from its top. Calculations suggest that the US market alone can support over 15,000 more stores. Family Dollar’s expansion initiatives could position the firm to take advantage of its competitors in some areas that the business has not yet fully penetrated. However, estimated annual square footage growth is estimated at 6%, at least until 2015, while Dollar General (NYSE: DG) and Dollar Tree (NASDAQ: DLTR) are projected to deliver 7% growth.
  • Roll-out of multiple initiatives: Several initiatives like the roll-out of tobacco, an aggressive remodel campaign and a distribution agreement with McLane generate considerable prospects to narrow the gap -- $2.00 of earnings potential per share -- with Dollar General. Although completely eliminating this distance seems unlikely in the short run, getting halfway closer could add around 30% to the company’s earnings.
  • Close gap against competitors: While being positioned somewhat behind its competitors in similar productivity initiatives, an opportunity to imitate some of their policies arises. More effective and efficient implementation could bring success to Family Dollar, helping close the aforementioned gap with Dollar General.
  • Store renovation: An ongoing plan to comprehensively renovate, relocate or expand stores is being executed. Family Dollar's management assures shareholders (in an earnings call transcript) that by the end of fiscal year 2013, about 60% of stores will offer customers an enhanced shopping experience. Initial results look promising as renewed shops have consistently provided comps above the average.

Threats

  • Unproven success: Even though key management positions have been renewed (Mike Bloom as President and COO in September 2011, and Mary Winston as CFO in April 2012), initiatives to improve productivity and profit margins have shown limited success. A history of irregular (and not as successful as its competitors’) administration leads many investors toward caution when considering investing in Family Dollar.
  • Stores overlapping: Store overlap is an item of concern. While not extremely high, it is not insignificant either. Overlapping (within a 3 mile radius) with other dollar stores reaches figures as high as 55% and over 40% for supermarkets. Wal-Mart’s incursion in the small box format opens the possibility of greater overlapping and competition in the future. In this area, Family Dollar faces a disadvantaged position against Dollar Tree, which already experiences the greatest Wal-Mart overlap (75%) but still provides the highest operating (EBIT) margins, proving to be less vulnerable to the advances of the retail giant.
  • Increased capital expenditures: As a result of Family Dollar's aggressive expansion campaign, capital expenditures rose from $130.9 million for the first quarter of fiscal 2012 to $196.4 million in fiscal 2013’s first quarter, and almost doubled from 2011 ($345.268 million) to 2012 ($603.313 million). Capital expenditures are expected to keep on growing during 2013 and could reach $650 million. Although it certainly is a bet on the long-run, the stock may experience some short-term pressure.

Conclusion

Within the promising dollar store segment, Family Dollar seems to offer the best investment prospects. Both Dollar General and DollarTree and great companies but offer limited upside.

Dollar General is one of the premier companies in retail with an attractive business model, first class management and growth profiles, but the stock offers limited upside compared to Family Dollar. In addition, its sales momentum seems moderate. Dollar General has staged a dramatic turnaround and transformed the company into a leading retailer. It is trading at 17.8x earnings and 1.03x sales, compared to Family Dollar´s 16.6x P/E and 0.76x P/S.

DollarTree has one of the most differentiated concepts (all its merchandise is priced at just $1), a superior growth opportunity and is more immune to Wal-Mart entry risks. Its operating margin already leads the industry and does not have the same opportunity for improving store operations and merchandising that Family Dollar does. In other words, its gross margin is likely capped at current levels.

However, potential upside is not the only element to observe before investing. Despite the projected upside, I recommend caution. While various factors point towards the development of the company, some important risks and threats should be taken into account in order to make a wise choice.


Victor Selva 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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