This Discount Retailer Trades at No Discount

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

The economy improves step by step, but low-income families remain under pressure.

In light of this fact, the performance of discount retailer Family Dollar Stores (NYSE: FDO) looks strong. The company has recently released its earnings report, beating analysts’ estimates by $0.02. The stock reacted positively and gained 7.1% on the day on the report. The shares are up only 11% this year, so is there more room for growth?

Margins

If you need just one key takeaway from the report, it would be the fact that lower-margin consumables sales grew while higher-margin discretionary sales declined. The same trend was highlighted earlier this summer in the quarterly report of Dollar General (NYSE: DG). Dollar General has cut its guidance and stated that sales growth was moderating.

Family Dollar Stores, which operates at a 6.95% margin, continues to underperform its peers on this front. Dollar General enjoys a 10.20% margin, while another discount retailer, Dollar Tree (NASDAQ: DLTR) operates at a 12.59% margin. The margin story contributes to the fact that Family Dollar Stores was not the fastest moving stock in the group. Dollar General is up 26% this year, while Dollar Tree is up 33.5%.

As the stock market is more interested in the future rather than the past, it would be interesting to learn what the margin trends will be in the second half of the year. Currently, the low-end consumer is focused on their basic needs, hence the rise in consumables sales. Another factor that contributed to lower discretionary sales was weather. You cannot predict weather for a half-year period, so we’ll leave it aside.

Current trends show that while those who are better off financially see improvements in their financial situation and are more eager to spend, this is not the case for people with less income. Discount stores generally target low and mid-income families, and these families remain under pressure. I don’t see drivers that would make a significant shift on this front in the near term.

Valuation

After the recent rise in the share price, Family Dollar Stores trades at a 16.7 forward Price/Earnings (P/E) multiple. Thius makes the stock slightly overvalued compared to its peers. Dollar General trades at 15 forward P/E, while Dollar Tree trades at 16.6 forward P/E. The last is the most conservative company if judged by capital structure with a 0.15 debt-to-equity. Family Dollar Stores has a 0.35 debt-to-equity ratio, while Dollar General has 0.55 debt-to-equity ratio. Family Dollar Stores is on track to open about 500 stores this year, hence the need for financing. Dollar General is active too, opening 165 stores in the first quarter. Family Dollar Stores is the only one of the three that pays a dividend, which yields a modest 1.49%.

Bottom line

Family Dollar Stores has under-performed this year, gaining just one third of what other two discounting stores have managed to gain. However, I do not think that the retailer will be able to close this gap and rise another 20% or so. I see no significant catalyst for this.

The low-end consumer continues to remain under pressure. The economy is improving, but this does not transfer into tangible benefits for those who most need them. Family Dollar Stores looks fairly valued. I think that the stock would depend more on the general stock market performance than on anything else in the coming three months.

The same is true for Dollar General and Dollar Tree. Both stocks look fairly valued. If these retailers managed to improve their margins, it would have been a big mover for them. However, I don’t see this coming in the near term. 


Vladimir Zernov 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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