Family Dollar Stores Still Thriving

By Greg Sushinsky | January 04, 2010 AAA

Family Dollar Stores (NYSE:FDO) continued its upward earnings trend, proving critics wrong or at least confounding them for the moment, concerning the dollar discount industry's staying power. While Family Dollar and some of the other deep discounters have been strong earners throughout the recession, many observers felt the run was due to end soon with a slowly improving economy on the horizon. However, Family Dollar's report for its first quarter, which concluded at the end of November, was full of positives. (For post-recession investment ideas, read Rules For Post-Recession Investing.)

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The Discounters Have Their Day

This recession has been the home of value, bargain hunting, discount and deep discount retail. Family Dollar's revenues increased from $1.75 billion to $1.82 billion, while its earnings rose from 59.3 million to $67.6 million for its first quarter. The per-share figures are 49 cents versus 42 cents in last year's same quarter. Margins inched upward, as the company did best on consumer staples and had lower markdowns, while same store sales increased 2.4% for the quarter.

Is It Sustainable?
This is the dollar store question. Family Dollar is riding high and so are its colleagues in the dollar discount space. Dollar General (NYSE:DG) took advantage of the friendly dollar-discount environment to go public again and recently showed increased interest on the street as it picked up analyst coverage. Dollar Tree (Nasdaq:DLTR) has also been posting good results, as has the extreme discounter, 99 Cents Only Stores (Nasdaq:NDN).

The stock was boosted by the surprise first quarter report, as there was speculation short sellers were also scrambling to cover the stock. Family Dollar's December sales, which will be included in its second quarter, were weakening, but have since rallied, so the company gave encouraging forward guidance. For the near future at least, it looks as though Family Dollar will continue to do strong business.

Possible Pitfalls
Dollar General, which is still 88% owned by Kohlberg, Kravis, Roberts & Co., recently had a strong Q3 earnings report, has plans to expand stores and there are equally strong consensus earnings estimates for this year and next. One wonders if these aren't slightly optimistic, as even as recently as last year, the company had a very rough third quarter.

One investor's note on 99 Cents Only Stores indicated that leveraging along with the "deflationary consumable goods prices" are the reason for the success. Investors can keep these factors in mind, despite the optimistic-looking estimates going forward for Dollar Tree, Dollar General and even Family Dollar.

The larger discounters such as Big Lots (NYSE:BIG), or even the wholesalers such as Costco (Nasdaq:COST), have a much broader base to draw from, the argument goes, so they will be able better to sustain their business than the narrow, extreme-value niche players such as the dollar stores.

Family Dollar's Place
The argument by Wall Street that the dollar stores have had their day during the recession and that they're done is clearly not the case, at least not yet. The simplistic reasoning that it's necessarily an either-or proposition, that either the dollar discounters function well during lean times or badly during good times, will be challenged by the remodeled business approach of both the dollar discounters and the consumers' shift in habits.

Is the consumer shift permanent? Not every former Saks' customer (NYSE:SKS) will suddenly bolt to Family Dollar to buy dollar baskets of makeup and perfume along with a bag of Cheetos, but the continuing strong performance of Family Dollar and some of the others suggests that some of the inroads these companies have made into drawing middle-class consumers will stick. If so, then that's where ultimately the market may mis-price these stocks, and where value investors can capture a good deal. (Some industries thrive in recessions. To find out more, check out Industries That Thrive On Recession.)

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