Family Dollar Misses, Profit Rises

The economic recovery is still patchy, and bargain hunters are going from one shop to another to grab the best deal, with their primary focus being on consumable items, and Family Dollar Stores Inc. ( FDO - Analyst Report ) , the operator of self-service retail discount store chains, remains successful in luring cautious consumers amid a fragile economic recovery.

This was quite evident from the company’s third-quarter 2012 results. The quarterly earnings of $1.06 per share jumped 16.5% from 91 cents earned in the prior-year quarter on the heels of healthy sales witnessed in the Consumables and Seasonal & Electronics categories, and marked a 17^th successive quarter of double-digit growth. However, earnings missed the Zacks Consensus Estimate by a penny.

The company had earlier guided earnings in the range of $1.01 to $1.11 per share for the quarter. Management now expects earnings between 71 cents and 81 cents for the fourth quarter and in the range of $3.60 to $3.70 per share for fiscal 2012.

The current Zacks Consensus Estimates for the fourth quarter and fiscal 2012 are 77 cents and $3.67, respectively.

We observe that Family Dollar’s strategic initiatives to improve merchandising and store operations have aided top and bottom line growth.

Let’s Unveil the Picture

Family Dollar posted a 9.6% increase in revenue to $2,360 million from the prior-year quarter, and reflected sales growth across Consumables (up 12.2%), Seasonal and Electronics (up 15.4%) and Apparel and Accessories (up 1.1%), partially offset by Home Products (down 1.8%). However, total revenue fell short of the Zacks Consensus Estimate of $2,373 million.

Family Dollar, which faces stiff competition from Wal-Mart Stores Inc. ( WMT - Analyst Report ) and Dollar General Corporation ( DG - Snapshot Report ) , continues to expect fiscal 2012 net sales to jump by 9% to 10%. We believe effective pricing and inventory management, private label offering, expanded operating hours and merchandise initiatives should drive sales.

The company’s point-of-sale technology and store realignment initiatives better position it to drive traffic, meet customer-oriented demand and improve in-store shopping experience. Consumers with lower disposable incomes are now prioritizing their purchases and looking for low-priced options. The company trades in merchandise generally priced under $10.

Based in Matthews, North Carolina, Family Dollar hinted that comparable-stores sales are on the rise on improved traffic count and increase in average consumer transaction value. Deeper focus on consumables helped Family Dollar to drive business from budget-constrained consumers.

Comps jumped 5% in the quarter compared with a growth of 4.7% in the prior-year quarter. Management reiterated fourth quarter comparable-store sales growth of 5% to 7%, and projected an increase of about 5% for fiscal 2012 comps.

The sales in the quarter were driven by the lower-margin Consumables category that registered double-digit sales growth. Given the dismal economy, consumers remain focused on basic necessities, such as food, and with Family Dollar offering low cost options, it remains the choice of shoppers.

The robust sales of lower margin merchandises, increase in markdowns and rise in inventory shrinkage weighed upon the company’s gross margin that contracted 40 basis points to 35.8%. Operating margin shriveled 20 basis points to 8.4%.

Other Financial Details

Family Dollar ended the quarter with cash and cash equivalents of $120.9 million and total long-term debt of $532.5 million, reflecting a total debt-to-capitalization ratio of 28.9%, and shareholders’ equity of $1,312.5 million. Capital expenditures for the first nine months were $391.4 million. Management now anticipates capital expenditures between $650 and $675 million for fiscal 2012.

During the first nine months of fiscal 2012, the company repurchased 1.7 million shares, aggregating approximately $91.6 million. As of May 26, 2012, the company still had $245.7 million at its disposal under its share repurchase program.

Stores Update

During first-nine months, Family Dollar opened 287 stores and closed 43 taking the total store count to 7,267. The company also renovated, expanded, or relocated 583 stores. Through fiscal 2012, the retailer plans to open about 450 to 500 new stores and close 60 to 80 stores.

Closing Comment

The economy is still not completely out of hibernation and consumers will remain cautious on their spending, buying only those things that fulfill their basic needs. Consequently, we could see more competitive pricing and new products to attract shoppers.

A price war would definitely eat away margins, which in turn would affect the company’s results. In order to remain competitive, it would be better to try out innovative ways to win the heart of target consumers.

Currently, we maintain our long-term Neutral recommendation on the stock. However, Family Dollar shares maintain a Zacks #2 Rank that translates into a short-term Buy rating.