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Family Dollar Stores, Inc. (FDO): A Discount Retailer to Watch

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Family Dollar Stores, Inc. (NYSE:FDO)Discount store Family Dollar Stores, Inc. (NYSE:FDO) has been constantly looking to expand its neighborhood stores and widen its reach by opening new stores, renovating existing ones, adopting innovative merchandising strategies, and expanding the supply chain. This was the reason why the company saw an improvement in revenue in its previous quarterly report.

But the company’s margins fell because of higher sales of low margin products leading to a fall in earnings. Is Family Dollar Stores, Inc. (NYSE:FDO) a stock to buy despite its margin problems or should investors be more cautious? Let’s take a look.

Earnings analysis

The business model is a decent one but has been under pressure recently. After recording substantial improvement in its net profit consecutively in the first and second quarters, Family Dollar Stores, Inc. (NYSE:FDO) added around 129 new stores in the third-quarter. Net sales improved 9% in the third quarter as comparable store sales grew 2.9% whereas profit fell to $120.9 million in the quarter from $124.5 million last year.

Family Dollar’s strategic plans helped it record a substantial increase of 9% in revenue to $2.57 billion in the third quarter. Comparable store sales went up as a result of an increase in average ticket size and higher customer traffic. Gross profit for the quarter improved 5.6% to $892.5 million, coming in at 34.7% of net sales, compared to $845.3 million, or 35.8% of net sales last year. Hence, gross profit declined more than 1 percentage point as sales of lower margin consumable items upset the company’s margin.

Strategies and outlook

It is impressive that Family Dollar Stores, Inc. (NYSE:FDO) is increasing revenue, but it is doing so by selling low margin items such as tobacco and other consumables. While this might be pinching the company now, it can probably derive more revenue and see an increase in the basket size of purchases which had happened in the third quarter. But the company needs sales of discretionary items to improve and if this does happen ultimately in the future then margins should increase again.

Family Dollar Stores, Inc. (NYSE:FDO) expects good results in the fourth quarter due to the sales-driving initiatives including strong merchandising. Since the June sales trends were very positive, the company expects that comparable store sales in the fourth quarter of fiscal 2013 will increase around 3%. Family Dollar Stores, Inc. (NYSE:FDO) also expects that gross margin pressure and SG&A leverage in the quarter will be minimal.

Earnings per diluted share are estimated to be between $0.82 and $0.87 per share as compared with $0.75 per share in the fourth quarter last year.  Diluted earnings per share are estimated to be between $3.77 and $3.82 in 2013 compared to $3.58 per share in fiscal 2012.

The company is looking to add approximately 500 new stores during the current fiscal year while closing down 30-50 low-yielding ones. It has earmarked capital expenditure of between $750 million and $800 million for this activity along with expansion of its supply chain.

According to management, “We are focused on stabilizing gross margin, controlling expenses, improving inventory productivity, and driving greater operational efficiencies. I am confident that we remain well positioned for long-term profitable growth,” said Howard R. Levine, Chairman and CEO.

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