What Family Dollar Stores, Inc. (FDO), Target Corporation (TGT): Does Billionaire John Paulson See In Family Dollar?

In May, billionaire John Paulson’s Paulson & Co. filed its 13F with the SEC, disclosing many of its long equity positions as of the end of March. We track filings from funds such as Paulson’s as part of our work developing investment strategies (for example, we have found that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year) and because we maintain this database we can also look for big changes in his portfolio over time. It turns out that during the first quarter of 2013, Paulson initiated a position of 5 million shares in Family Dollar Stores, Inc. (NYSE:FDO), making the dollar store his largest new holding for the year. See the rest of Paulson’s stock picks. While we don’t recommend blindly following hedge funds (and Paulson has actually not been doing too well recently) we think that their picks can serve as sources of initial investment ideas.

The second quarter of Family Dollar Stores, Inc. (NYSE:FDO)’s fiscal year ended in early March. Revenue grew by 18% versus a year earlier, though there was an extra week in the quarter so in per-week terms the growth rate would be about half as high. In addition, the company’s margins fell and so the quarterly report actually showed total operating income being about flat (as was the case for fiscal Q1 as well). This suggests that while the market for dollar stores is not being saturated yet- as shown by the continually strong performance on the top line- Family Dollar Stores, Inc. (NYSE:FDO) is having trouble keeping its costs in line. In the first half of its fiscal year, cash flow from operations was down by nearly 40%, and again that is with an extra week.

At its current valuation Family Dollar Stores, Inc. (NYSE:FDO) trades at 17 times trailing earnings, so the market is actually expecting EPS to improve moderately over the next several years. Family Dollar Stores, Inc. (NYSE:FDO) has been buying back stock, but the multiple is high enough that the valuation likely does depend on improving net income. It should be noted that the stock’s beta is low, at 0.4, but the same is the case for other dollar stores and even other discount retailers such as Target Corporation (NYSE:TGT) and Wal-Mart (NYSE:WMT). Trian Partners, managed by billionaire Nelson Peltz, is another major shareholder in Family Dollar with the fund’s most recent filing disclosing ownership of almost 9 million shares (find Peltz’s favorite stocks).