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Family Dollar Stores, Inc. (FDO): Don’t Be Fooled by This Discount Retailer’s Recent Results

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The reaction to discount retailer Family Dollar Stores, Inc. (NYSE:FDO)’ recent results was surprising to me. The company met revenue estimates and delivered a beat on the bottom line, and as a result, shares spiked a tad over 7% as investors rejoiced the company’s solid performance in the third-quarter. But then, that’s not the sort of celebration one should indulge in when a company trims its earnings guidance and is facing margin challenges.

I believe that investors were a bit too optimistic and Family Dollar Stores, Inc. (NYSE:FDO) isn’t a good bet when compared to the likes of Dollar General Corp. (NYSE:DG) and Dollar Tree, Inc. (NASDAQ:DLTR), and this clearly reflects in the year-to-date stock price performance of the three companies.

Looking beyond the results

The headwinds that Family Dollar Stores, Inc. (NYSE:FDO) is facing aren’t new and I’d predicted that the company would have a tough time this year. A closer look at its recently released results will confirm the fact that the challenges still exist and might continue to trouble the company going forward.

Family Dollar logoSo, even though Family Dollar Stores, Inc. (NYSE:FDO) managed to grow same-store sales 2.9% and revenue jumped an impressive 9% from the year-ago period, net income declined close to 3%. This indicates that Family Dollar is selling more low-margin items and is keeping traffic intact at the cost of margins. Hence, it wasn’t surprising that its gross margin fell 1.1 percentage points and the trend looks set to continue.

Family Dollar Stores, Inc. (NYSE:FDO)’s focus on selling more consumables, such as tobacco and food products, has been hurting its margins. The company is not witnessing a boost in discretionary spending and the fact that 72.5% of its revenue was derived from sales of consumables, up from 69% last year, is indeed a worrying trend. However, if you are thinking that this is an industry-wide trend, you’re in for a surprise.

Rival Dollar Tree, Inc. (NASDAQ:DLTR) had witnessed greater growth in sales of its discretionary products last quarter than consumables, and so, Family Dollar Stores, Inc. (NYSE:FDO)’s strategy seems questionable as it is not being able to grow its discretionary segment. So, while Family Dollar’s target of opening 500 new stores this year is certainly impressive, it needs to rescue its margins and return to earnings growth, which is not going to happen this year.

And going by the trend of rising consumables sales, it might be difficult for Family Dollar Stores, Inc. (NYSE:FDO) to improve earnings in the near future. Moreover, as Fool analyst Demitrios Kalogeropoulos pointed out, the company will be making capital expenditures to the tune of $600 million on installing freezers and refrigerators to store those consumables. In comparison, Dollar Tree, Inc. (NASDAQ:DLTR)’s expected capital expenditure of $320 million to $330 million in the ongoing fiscal year reveals the difference in strategies.

Who’s the boss?

So, it’s pretty much clear why I think that Family Dollar Stores, Inc. (NYSE:FDO) isn’t the best dollar store to invest in and a look at its peers will further solidify my position. Almost all dollar stores discussed here trade at similar trailing P/E multiples of between 18 and 19, but Family Dollar has the highest PEG ratio of 1.52 while Dollar General Corp. (NYSE:DG) and Dollar Tree, Inc. (NASDAQ:DLTR) sport PEG ratios of 1.08 and 1.05, respectively.

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