Why Family Dollar Is Not the Best Dollar Store

Why Family Dollar Is Not the Best Dollar Store

Discount retailer Family Dollar Stores has failed to impress this year. Higher sales of low-margin items were pushing up sales earlier at the cost of margins, but now it seems that the retailer is falling prey to stiff competition. While peers Dollar General and Dollar Tree posted decent same-store sale figures in the previous quarter, Family Dollar failed to inspire.

Not impressive
In fact, while management had expected same-store sales to increase 2% in the recently reported fourth quarter, the metric actually stayed flat from the year-ago quarter. Compare this to Dollar General's impressive same-store sale growth of 5.1% and Dollar Tree's 3.7% jump in their latest quarters, and it becomes quite evident that Family Dollar is lagging behind.

Family Dollar's revenue of $2.5 billion, which was up 5.8% from the year-ago period, missed the $2.57 billion Street estimate. Unsurprisingly, revenue growth was less than what was seen at both Dollar General and Dollar Tree in the last quarter. However, Family Dollar did manage to turn in an impressive bottom line performance.

Adjusted earnings increased 14.7% to $0.86 per share and beat the $0.84 consensus estimate. Bottom line growth was helped by lower freight costs and better margins as a result of its private-label sales and cheaper sourcing of items. This seemed to be the only bright spot in an otherwise disappointing quarterly report and the going looks set to become even more difficult in the future.

According to CEO Howard Levine, "High unemployment levels, higher taxes and continued uncertainty in Washington will likely continue to pressure our customers' income." As such, Family Dollar expects its same-store sales to decline in the low-single digits in the ongoing quarter, down from the 6.6% increase that it had witnessed last year.

Family Dollar's strategy of promoting its consumables items and tobacco has worked well so far. The company had added 1,000 new consumable items in fiscal 2012, driving sales higher by 17% in fiscal 2013. But then, Family Dollar has got some stiff competition from Dollar General in sales of tobacco products.

Intense competition
Dollar General has completed the roll out of tobacco products across all its stores. The discount retailer claims that two-thirds of its customers who buy tobacco also purchase other items, thereby leading to a bigger basket size. Now, Dollar General -- with 11,000 stores -- is considerably bigger than Family Dollar, which operates 8,000 stores.

Moreover, Dollar General's store expansion plan looks more ambitious than Family Dollar. The company's plan is to open a total of 650 new stores in the ongoing fiscal year, with 375 openings already achieved by the end of the second quarter. In comparison, Family Dollar plans to open 525 new stores in the current fiscal year, which means that the bigger Dollar General is growing its foot print at a faster pace.

Hence, with a wider and fast-growing network of stores, there is a higher probability that consumers looking to purchase tobacco products might walk into a Dollar General rather than Family Dollar.

In addition, the competition from the smaller Dollar Tree is also increasing. With around 4,800 stores, Dollar Tree is no doubt smaller than Family Dollar, but the company sees great opportunity going forward. Dollar Tree management claims that there is potential for up to 7,000 stores in the U.S. More importantly, Dollar Tree is also looking to drive sales of its consumable items.

Dollar Tree sells frozen and refrigerated products in around 3,000 stores and is on track to add 550 more stores to the list this fiscal year. Moreover, the productivity of new Dollar Tree stores was the highest in 2012 in a decade and it is seeing similar patterns this year as well. Dollar Tree had recorded revenue growth of 8.8% in the last reported quarter along with positive same-store sales.

All this indicates that Dollar Tree is moving in the correct direction. The company is doing its bit to make competition in the industry even more intense.

Final words
Family Dollar appears to be under siege from different angles. And given the company's valuation when compared to its peers, investors should consider staying away from it. Family Dollar is slightly cheaper at 18 times earnings when stacked up against Dollar General's 19x earnings and Dollar Tree's 21x.

However, Dollar General and Dollar Tree have been reporting positive same-store sales and trade cheaply if we take a look at the PEG ratio. A PEG ratio of 1.60 indicates that Family Dollar is expensive as against Dollar General's 1.16 and Dollar Tree's 1.22.

Hence, Family Dollar is not exactly cheap and investors would be better off taking a closer look at its peers that look like better options due to better revenue growth and ambitious expansion plans.

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The article Why Family Dollar Is Not the Best Dollar Store originally appeared on Fool.com.

Harsh Chauhan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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