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Risk-Reward Balances Family Dollar

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Family Dollar Stores Inc.’s strategic initiatives to improve merchandising, marketing, and store operations have resulted in sustained growth in the top and bottom lines. Management now expects a growth of 8% to 10% in net sales and an increase of 12.2% to 20.2% in earnings per share in fiscal 2012.

We believe there is a tremendous opportunity to increase sales and gross margin through effective price management, cost containment, tighter inventory control, private label offering, expanded operating hours and merchandise initiatives. Moreover, in order to enhance its market share Family Dollar intends to focus on both consumable and discretionary categories.

Family Dollar offers general merchandise in four categories––consumables, home products, apparel and accessories, and seasonal and electronics––and sells merchandise at prices from under $1 to $10. 

All these initiatives helped Family Dollar to post healthy fourth-quarter 2011 results. The quarterly earnings of 66 cents a share outpaced the Zacks Consensus Estimate of 64 cents, and jumped 17.9% from 56 cents earned in the prior-year quarter on the heels of healthy sales witnessed in the Consumables, and Seasonal and Electronics categories.

North Carolina-based Family Dollar now expects first-quarter 2012 earnings between 65 cents and 73 cents, and fiscal 2012 earnings between $3.50 and $3.75.

The operator of self-service retail discount store chains posted a 9.1% increase in revenue to $2,134.3 million from the prior-year quarter, and reflected sales growth across Consumables categories (up 12%), Seasonal and Electronics (up 9.2%), Apparel and Accessories (up 0.5%) and Home Products (up 0.1%). Total revenue also came ahead of the Zacks Consensus Estimate of $2,122 million.

The company has also been actively managing its cash flows, returning much of its free cash to shareholders through share repurchases and dividends. The company has also been making prudent investments related to store infrastructure; store openings, expansions and relocations; and improvement of distribution centers to drive revenue growth.

However, Family Dollar operates in the highly competitive discount retail merchandise sector. Peer pressure from the likes of Wal-Mart Stores Inc. (WMT - Free Report) and Dollar General Corporation (DG - Free Report) will likely continue to weigh on its results.

Moreover, the company’s customers remain sensitive to macroeconomic factors including interest rate hikes, increase in fuel and energy costs, credit availability, unemployment levels, and high household debt levels, which may negatively impact their discretionary spending, and in turn the company’s growth and profitability.

Going by the pulse of the economy, we believe that consumers will remain cautious on their spending this holiday season, and thereby we could see more competitive pricing and new products to attract shoppers. We believe that retailing companies will leave no stone unturned to win the hearts of bargain hunters and it definitely remains a wait-and-watch story as to who emerges successful in wooing consumers in this distressed economy.

Given the pros and cons we currently maintain our long-term Neutral recommendation on the stock.

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