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Family Dollar is Fully Valued After Icahn Bounce

June 09, 2014 | About:
Chris Mydlo

Chris Mydlo

24 followers

Carl Icahn disclosed his 9.39 percent stake in Family Dollar Stores (FDO). After the nearly 14 percent price increase in the stock, the total position is valued at about $738 million. The Schedule 13D filed with the SEC states that Icahn (Trades, Portfolio) intends to “seek to have conversations with member o the Issuer’s senior management and board of director to discuss the Issuer’s business and strategies to enhance shareholder value, which may include the pursuit of operating initiatives or the exploration of strategic alternatives.”

Fox Business reported that Icahn (Trades, Portfolio) would consider pushing for a merger with rival Dollar General. According to market cap, Dollar General is 2.5 times larger than Family Dollar. Looking at the Family Dollar’s income statement, the pursuit of operating initiatives is another objective that can increase shareholder value. The company receives high scores from GuruFocus for Business Predictability (4/5), Financial Strength (7/10) and Profitability & Growth (8/10). Where the company is deficient is in its margins. Its net margin for the latest quarter was only 3.34 percent compared to net margins of 4.92 percent from Dollar General (DG) and 6.91 percent from Dollar Tree (DLTR). Getting the net margins on par with Dollar General will give the company a boost in income of 47 percent. I think that would be more rewarding for shareholders than a merger with Dollar General.

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It is not going to be a quick fix for Family Dollar. Trouble has been brewing on the horizon and management has been working on strategic actions to help strengthen the company. Icahn can now help advise the team with their strategic actions. The actions include closing 370 underperforming stores, slowing down growth in opening new stores, reducing corporate overhead and lowering prices on basic items to deliver more compelling value. The company expects to record an estimated $85 million to $95 million restructuring charge in the second half of the year. Workforce reductions and store closings are expected to deliver an estimated $40 million to $45 million annually.

In comparison to its competitors, Family Dollar now has the highest P/E of 20.14. Dollar Tree has a P/E of 20.06, and Dollar General has a P/E of 19.84. Although it has the highest P/E, Family Dollar is the only company out of the three to have negative earnings growth over the past 12 months. Without the help of Icahn, the stock is only estimated to grow at 4 percent annually for the next five years. At that rate the company has already hit its terminal growth rate. Without Carl Icahn (Trades, Portfolio) entering the picture and the new initiatives by the company, Dollar General is a much better deal with a slightly lower P/E and an estimated growth rate of about 14 percent over the next five years compared to only 4 percent growth for Family Dollar.

It is a good sign for the company that changes are on the agenda, but the stock is now slightly overvalued until the company can show some improvements. Family Dollar is a no growth stock and was on its way to $40 per share. The recent developments bring promise back to the company and it should trade near its 10-year median P/E of 17.6. The stock has made its move, and I do not expect it to go anywhere from here until the company can improve on its margins. With the median P/E, the stock is valued at $60.90. At this time, the stock is trading at $68.56 per share. As for any merger, it will likely be at least a year before any serious discussions take place. Family Dollar has adopted a one-year poison pill with a trigger of 10 percent.

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Rating: 5.0/5 (3 votes)

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Comments

rrurban
Rrurban premium member - 1 month ago

FDO is more than fully valued. It certainly is not worth $70. It's worth MAYBE $40. Nothing I can see supports a $70 valuation. FCF generation (no). Assets (no). Cash (no)

chris mydlo
Chris mydlo premium member - 1 month ago

You are correct, Rrurban. It is now fully valued considering the new expectations of Icahn helping turn it around and bringing the margins back in line with its competitors. Without it... $40.

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