Family Dollar Stores (NYSE:FDO) operates retaildiscount stores in 45 states of the U.S. Through more than 8,000 locations, the company offers general merchandise to mid- to low- end consumers at prices that typically range from less than a dollar to $10. Its main category is consumables, which accounted for 75% of total revenues in the first quarter 2014. The firm also sells home products, apparel and accessories, seasonal and electronics. Its average 7,200-square-feet stores are strategically located in urban, suburban, rural and small town markets.
Family Dollar mainly caters for low-income consumers. The great recession, therefore, dragged many more customers to its bay, and while the retail industry was in a downward spiral Family Dollar, as well as its competitors Dollar General Corporation (NYSE:DG), and Dollar Tree Stores Inc. (DTLR), thrived. During the recessive period, the company’s operating margins increased from 5.2% to 7.5% and its comps jumped from a flat 1% to an average of 5%. Its competitors achieved similar results, while Wal-Mart Stores Inc. (NYSE:WMT) showcased negative comps during this time.
Nevertheless, concern arises from the fact that Wal-Mart has undertaken a roll out of its Express locations to compete with the dollar store concept. The scale of its business poses a considerable threat to dollar stores, given its huge purchasing scale and low distribution costs. General Dollar also pressures Family Dollar’s margins, since the firm has a larger store base which is aggressively expanding and it also possesses greater brand recognition, market presence and financial resources.
An important part of Family Dollar’s growth in the last years derived from the implementation of government assistance programs, since 40% of dollar store customers receive some type of government help. The U.S. Department of Agriculture informed that beneficiaries to the Supplemental Nutrition Assistance Program increased from 26 million in 2008 to approximately 47 million in 2012.
However, in November 2013, the government made effective its outlay cuts to SNAP, thus affecting customers’ household budgets. A slow economic recovery with high levels of unemployment and household debt, as well as increases in energy and fuel costs, also continue to contract consumers’ discretionary spending.
Adapting Its Offer to the Market Needs
In order to offset the economic downtrend, Family Dollar switched focus onto enhancing its consumables offer, which reported an increase of 4.7% in first quarter 2014, countering the decline in the sale of discretionary products. The addition of 500 private brand SKUs to its offer in fiscal 2013 and another 200 planned for fiscal 2014, is also expected to boost results.
The expansion of its store base is also expected to improve sales as well as keep the company at pace with its competitors. Therefore, Family Dollar plans to increase its locations at a rate of 5% to 7% square footage growth in the next three to five years.
Headwinds Blowing Profits Away
In spite of its efforts to keep business afloat, the company reported soft first quarter 2014 results with a decline in comparable –store- sales of 2.8% in this period and 3% in December. Also, top line growth has been decelerating sharply in the last quarters reporting increases of 17.7%, 9%,5.8% and 3.2% for the second, third, fourth quarters of fiscal 2013 and the first quarter of fiscal 2014 respectively. Consequently, the firm has lowered its earnings expectations for fiscal 2014.Family Dollar stocks trade at 16.6 its trailing earnings compared to an industry average of 18.8.and showcases a dividend yield of 1.60 compared to its peers’ 1.95 average. Investment guru John Paulson (Trades, Portfolio) recently reduced his holdings by 13.37% in accordance with my bearish feeling about Family Dollar’s growth potential.
Disclosure: Vanina Egea holds no position in any stocks mentioned.