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.
Competition
The expansion is of great importance here as Family Dollar Stores, Inc. (NYSE:FDO) is competing against Wal-Mart Stores, Inc. (NYSE:WMT) and Dollar General Corp. (NYSE:DG) both of which are bigger in size as compared to Family Dollar. Its 7,600 stores are less than Dollar General’s more than 10,600 stores while Wal-Mart has an identical count as well.
Wal-Mart Stores, Inc. (NYSE:WMT) is also ahead of dollar stores in pricing its products as Bloomberg Industries found in a survey. According to the survey, Wal-Mart beat Dollar General in pricing 100% of the time when considering household goods while auto supplies, pharmacy and health and beauty aids and grocery were cheaper 85% of the time.
Another thing which might be a threat for dollar stores from Wal-Mart Stores, Inc. (NYSE:WMT) would be its expansion into residential areas. As Bloomberg Industries senior analyst Poonam Goyal said, Wal-Mart is penetrating stores in neighborhoods and eroding the advantage that dollar stores used to have so Family Dollar needs to beware the retail giant’s moves.
Dollar General is also cheaper than Family Dollar as one blogger found out. But Dollar General has not been performing of late as it also saw a drop in gross margin in the first quarter reported in June because it has been selling a higher number of consumable items and tobacco, and would require a jump in discretionary spending to actually improve profit. Revenue had grown 8.5% while same store sales had increased 2.6% which are almost identical to Family Dollar.
Conclusion
Family Dollar Stores, Inc. (NYSE:FDO) is growing revenue and expanding stores but it is being hurt by competition and constrained spending on high-margin items. Investors need to watch the company from the sidelines and check for signs of improvement and buy when the signs are visible.
The article A Discount Retailer to Watch originally appeared on Fool.com and is written by Amal Singh.
Amal Singh has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Amal is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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