In today's Oxen Group recap, we will be looking at Family Dollar (FDO) in our daily deeper look as they get close to their earnings report. We want to update our FDO 12-month price target as the year-ends and 2014 is starting to take shape. The Oxen Group covers Family Dollar year round, and we want to update our current pricing to reflect recent occurrences. In our Company News section, we will take a look at BlackBerry (BBRY) as we continue to believe that the company is a potential 100% gainer in 2014 and were in the news today. Additionally, as always, we will do our typical market overview and examine what's coming next for the market.
The market was stronger on Tuesday as 2014 has started out quite weak for the market. With the Fed starting to taper, the market is going to pay attention to reality a la economic data. If data is good, we believe the market has potential. If we see weakness in data, the market will correct. For that reason, we expect a pretty choppy market action all year. The trade balance rose to a four-year high, as exports were strong from China, Germany, and Japan. Imports were low as oil demand was down. That news coupled with comments, pre-market, from Boston Fed President Eric Rosengren set the market up for upside. Rosengren noted that he was cautious on taper and believed that there was no inflation in sight in data. While his comments were overall not bullish, they did suggest a more dovish environment existing for some time.
On the company news side, we will be focusing on BlackBerry today. At the beginning of the year we called BBRY one of our favorites for a potential 100% rise in the coming year. With valuations so low and expectations at rock bottom, the company likely just has to survive in order to see some more upside. Tuesday, the stock was rallying on quite a bit of volume after comments from AT&T (T) suggested that the stock might not be dead just yet.
AT&T's mobile chief, Ralph de Vega, noted that T is still behind BBRY:
"We're supporting their efforts to continue being a viable supplier," said Ralph de la Vega, head of AT&T's mobility business, in an interview with CNET. AT&T continues to work with BlackBerry, and de la Vega said he was meeting with BlackBerry interim CEO John Chen while in town during the Consumer Electronics Show. "I think John has a good plan," de la Vega said.
Those comments were enough to get the stock moving. They came before BlackBerry's conference Wednesday morning at the Consumer Electronics Show (CES), which we believe is a chance for new CEO John Chen to continue to instill confidence and be clearer about his plans for the business. Thus far, Chen has noted that he wants to redo the business with a focus on four divisions and move away from devices as being the main focus. Yet, the company is looking to hire Ron Louks, from HTC and Ericsson, to be its new device head. These comments from AT&T suggest that things are not at all over for devices. In fact, de la Vega continued to say there are still some very loyal to QWERTY keyboards.
We will be watching tomorrow's press conference closely. Here are the four important divisions we want to hear more about:
Chen has iterated that the company is no longer for sale, and that the company is looking to enterprise over consumer products moving forward. The company will have four target areas: hardware, enterprise, cross-platform messaging, and software. The company could definitely go places with messaging if they advance their technology and make it more widely available. The company also was once the enterprise leader, and they hope to get back to that place.
The question moving forward is what's next for BlackBerry. Today's comments suggest that the company may not be ready to get out of the device scene in the vein that we know. Further, they also suggest that there may be a keyboard focus, which is something that is not popular on the market right now. Tomorrow's report will be something to definitely watch. Either way, though, we like the prospects for 2014:
This is the make-or-break for BBRY. The company has to start to show that they can transform their business, shed the consumer-based market for other markets, and have success in the four key areas for the company. Execution is the key here, and the company will be skewered (and maybe bankrupt) if they cannot properly execute the four-prong plan. Yet, if they can start to see some pickup and reformation of the business, this story will move up, quick, fast, and largely. This is a stock that can grow 100% and potentially more…not that they will or are likely to. Yet, the upside potential is huge given that literally everyone appears to be against them.
Today, we are taking a look at Family Dollar. Coming into today, we had a Hold-rating with $67 price target on this name. We have actually slightly reduced our estimates from previous levels for 2014 to $63 to start the year. With shares currently valued just above those levels at $65, we recommend a Hold on Family Dollar. Current owners should stick with the name, but new upside looks limited for new buyers.
In this section, we will cover the current catalysts for the company as well as issues we foresee. We will conclude by breaking down how we got to our price target.
The main catalyst for Family Dollar is both a positive for it and a negative. On the one hand, the company is suffering from limited comparative sales growth that is more or less in line with GDP. The company's main consumer is still struggling with limited job growth, part-time work more popular, rising taxes, and sequester cuts. The company has battled that with a large growth plan for stores to bring about year/year growth. Yet, it is limited to the 5-7% annual square footage growth goal for the company. In the past year, the company opened over 500 stores, but comp sales were up just 3%. Additionally, the company has undergone major remodeling efforts to make stores friendlier, convenient, and push higher margins goods. That brings us to our main catalyst conversation: margin improvement.
While there is definitely some sluggishness to sales growth, the company has focused on execution as well as margin expansion efforts. 2013 was somewhat disappointing as gross and operating margins fell, but that was more due to sluggish sales as well as tough year/year comps from the introduction of consumables and refrigerated/frozen foods as well as tobacco products that did well in 2012. In 2014, we expect the company to bounce back and see a higher push in gross and operating margins.
The company is undergoing several initiatives that we believe are going to help margin expansion:
- Reinvigorate checkout lanes
- Direct-to-factory purchases
- Overseas distribution offices
- Checkpoint systems
- Door-to-shelf pallet program
These five initiatives are comprehensive and show a real push to increase margins and store productivity as well as reduce shrink and increase inventory turnover. Let's start our examination with checkout lanes.
In the 500+ new stores in 2014 as well as 800+ being renovated, the company plans to introduce a new checkout lane program. The new checkout lanes are going to focus on speed with a better consumer-to-clerk interaction process as well as push sales of high impulse, high margin goods. These lanes are expected to help push gross margins as well as increase efficiencies.
One of the smartest moves the company made was to start pushing direct-to-factory purchases. The company has a goal to make 13% of products this fashion by 2015. Direct-to-factory products have lower initial markups and get better price points due to high volumes. By cutting out the middleman distributor, the company is able to make a lot more off each product. The company has furthered this by opening offices in Shanghai and Bangkok that allow them to go directly to key factories to get products. They can more easily check quality, limit markups, and oversee product delivery more effectively. These products are expected to bring much better gross margins because the initial markup is limited:
We increased our direct-to-factory purchases, and we remain on track to hit our goal of 13% of total purchases by the end of 2015. We have reduced costs by expanding our supplier base and increasing our geographical reach through new overseas offices in Shanghai and Bangkok. Initial markups on imported merchandise have improved significantly over the prior year, and we are introducing higher-quality merchandise to our customers.
Another margin expansion program is the Checkpoint system. This new system is going to allow the company to have better electronic surveillance of products in-store. What more, the company is working upstream and getting the system into suppliers before the products even hit the stores. The advantages here are that employees can spend less time tagging goods with Checkpoint in-store, meaning they are able to assist customers, have more checkout lines open, and increase efficiencies. One drawback, though, is that the company could see some suppliers not as effectively placing the systems.
Finally, we are most excited about the shelf pallet program. While this program is far behind the efficiencies of stores like Kroger (KR) and Walmart (WMT), the program is a big step. The company has basically streamlined their delivery and restocking program. Now, items will be presorted before on the truck and loaded onto pallets by department. When pallets come off the truck, they are ready to be taken right to the floor. This allows for less damage, shrink, employee injuries, and more efficient restocking. Once again, all these improve margins.
What we like about what we are seeing from FDO is that the company knows that just building stores and remodeling is not enough. Their consumer is just not as strong right now as other income levels, and they have to do something to attract profits. The company has done a great job of adding a lot of management pieces to help with supply chain and efficiencies. We believe they will see operating margins pushing towards 8% over the next couple years with these changes as well as many others that have been implemented over the last several years. Consumables, tobacco, and many new products are just many examples of ways the company has already made this move.
Yet, is margin expansion enough?
Revenue - The problem lies in revenue for FDO. In our projections, we see no way for the company to break out of the 4-6% growth range. GDP will be around 2-3% for the next couple years, and the low-income consumer is not even in line with these rates typically. New stores do help, but at some point, the company will be saturated. That is likely to happen sooner than later. Without a major product shift known right now, we projected this range for the next several years.
Operating margin - The positive is here, and we do see operating margin moving to 7.5%-8% over the next several years. Yet, one issue is that the company needs sales improvement. With large expenses from remodeling and expansion, the company needs more dollars in stores to cover fixed costs. With that stagnant, these measures can only do so much. Further, there is just a limit to the margins of discount stores. The company does lag Dollar General (DG) and Dollar Tree (DLTR) in margins, but these companies have worked very hard at COGS reductions that FDO is still not at right now.
Taxes - We see taxes staying in the 35-36% range.
Capital Expenditure - These should dip in 2014 back to around $600M as the company continues to expand stores and remodel. That plan looks to be in the works for several more years, so we see capex staying in this area. If the company reduces capex, it means new stores are not there, so revenue would be lower to offset the capex drop (neutralizing it).
With this updated model, we came up with a price target of $63. This model is definitely more conservative, but the company has had a couple rough quarters that have weakened our confidence in their ability to attract consistent higher sales as well as the pace of margin expansion. In the best-case scenario, where we see operating margins push to 9% in the next five years with sales up 6%-8% per year and capex down to $550M, the price of FDO could be much higher in the $90-$100 range. Yet, there is little reason to believe that these can be achieved given recent results. We need to see more movement in that direction to start to adjust our model. Thus, we see it as a solid Hold.
The market had quite a great day on Tuesday with economic data strong and the Fed's Rosengren giving some spark to the market believing that the Fed will continue to provide "free money" to the market. Tomorrow, the market will get the start of the big news with economic data about jobs tomorrow. Tomorrow, the market will get ADP Employment Change, which should rule the day. The estimates are for 203K job additions versus prior estimates at 215K. The market needs to see a beat here or we should see downside. We also get the FOMC Minutes tomorrow to put a cherry on top. This will show the market what exactly the Fed thinks about tapering and the future of QE in more detail. It is a packed day, and it could go either way based on these two reports. Look for the S&P 500 (SPY) and Dow Jones (DIA) to move up 0.5% - 1.0% if both are bullish as this market looks ready to move on good data.