Family Dollar Stores Inc. (FDO) operates discount stores in the United States with about 7,300 stores in over 40 states. The company is expanding and its value-driven model will keep consumers spending at Family Dollar no matter what happens with the economy. FDO has a shareholder oriented management and the company is a long term opportunity for value oriented investors. Hedge fund portfolio manager Lee Ainslie added to his existing position last quarter among other prominent investors. The stock is up 15% YTD and I think it is one of the most interesting opportunities in the discount retail sector. Warren Trades blog recommended FDO when the stock broke new highs in April 2012.
One of the strongest metrics in FDO comes from its accelerating pace of new store openings. Family Dollar opened 475 stores and expanded 854 stores during fiscal 2012. Through fiscal 2013, the retailer plans to open about 500 new stores and renovate, expand, or relocate 850 stores. The company projects store count to increase at a rate of 5% to 7% over the next 3 to 5 years. In fact, management has the goal of consistently delivering five to seven percent net new store growth, operating margin expansion, and double-digit earnings per share growth. The guidance for fiscal 2013 align nicely with these long-term goals. Despite a challenging macro environment, Family Dollar's strategic initiatives to improve the merchandising, marketing, and store operations have resulted in sustained growth in the top and bottom lines.
Considering the weak macro scenario, I think that value-driven consumption is still well in play. High levels of unemployment and stagnant wage growth changed consumer spending habits because consumers simply don't have as much discretionary income as they've had in the past. This secular trend has driven the company's gains and will continue to provide a tailwind moving forward. The holidays are easily FDO's best sales period. Family Dollar is effectively managing expectations and setting itself up to deliver upside sales and earnings surprises as it benefits from a seasonal boost. Even if FDO regular shoppers have smaller budgets, dollar stores' bargains may still attract new customers. According to Michael Keara, analyst at Morningstar, the key to the Family Dollar story is retaining the consumers obtained during the 2008 recession. He also explains that there is a risk that consumers trade out of the discount retailers when the economy eventually returns to prosperity, highlighting that this scenario would be against the backdrop of high square footage growth in the industry. While this is a potential considerable risk, I believe this is years away.
Family Dollar competes directly against Dollar General (DG) and Dollar Tree (DLTR). Recently Dollar General reported a strong revenue growth of 10% and grew its earnings by 47% compared to the same period in the previous year. Dollar Tree also reported strong earnings growth of 26%. Interestingly, FDO trades at the same P/E as DG and DLTR but the forward price earnings multiple is lower than the current P/E in each of these companies. This suggests that the market does not expect its superior growth to continue. Wal-Mart (WMT) and Target (TGT) are also indirect competitors to Family Dollar. These companies trade at a substantial discount to the dollar stores despite possessing superior brands. Wal-Mart trades at 16 times forward earnings and 14 times forward earnings estimates. Target's own trailing and forward P/E multiples are 14 and 13, respectively.
Several top institutional investors trust in FDO. Family Dollar's stock is owned by 385 funds, the highest number in company history. Some of them are names like Goldman Sachs, Citadel, SAC Capital and Maverick Capital. For the period 2008-2012, revenue growth averaged 9% per year, with EPS climbing on average 14% per year. Analysts reason that such growth could be tough to maintain even though they project 2013 revenue to climb 8%, with EPS up 13%.
In conclusion, I think that Family Dollar trading at a 19x P/E ratio does not represent an obvious value opportunity, but is one of the retail stories I find most compelling. With several quarters of consecutive revenue growth, 5 consecutive years of annual revenue growth in excess of 10%, strong balance sheet fundamentals and growing institutional interest, the stock could break recent new highs.