Why Family Dollar Cannot Compete Against Walgreen, Let Alone Wal-Mart

| About: Family Dollar (FDO)


Drugstores like Walgreen - not big discounters such as Wal-Mart - are dollar stores' main competition.

Dollar stores' low revenue leaves them in a poor position to compete with drugstores and Wal-Mart.

Walmart Express is designed to compete with drugstores like CVS Caremark, not dollar stores.

Dollar store operators like Family Dollar will have to end expansion and start closing stores just to survive.

Over-expansion and the inability to compete with drug store chains like Walgreen Co (WAG) are beginning to catch up with Family Dollar Stores (NYSE:FDO).

After several years of almost mindless expansion, the dollar store operator is in the midst of a round of store closings, shuttering 30 stores in its home turf of North and South Carolina alone. All told, Family Dollar is planning to close around 370 under-performing stores nationwide out of a total of 8,246.

The store closings come just as Family Dollar reported its first drop in revenue in years. On Feb. 28, 2014, Family Dollar reported $10.29 billion in TTM revenue, down from $10.47 billion in November. Family Dollar's TTM revenue had been growing steadily every quarter since 2009. In contrast, Family Dollar's rival, Dollar General (NYSE:DG), reported a modest TTM revenue increase in the same period. Dollar General reported a TTM revenue figure of $17.5 billion in January and $17.79 billion on April 30.

Family Dollar seems to be losing sales but to whom? Wal-Mart hasn't made its vaunted push into small box in most areas yet. The answer seems obvious when you take a look at revenue figures: drugstore operators such as Walgreen.

How Pharmacies Drive Sales and Hurt Family Dollar

Walgreen reported a TTM revenue figure of $75.28 billion on May 31, 2014, up from $74.19 billion in February. CVS Caremark (NYSE:CVS) reported a TTM revenue figure of $128.69 billion on March 31, 2014, up almost $2 billion from $126.75 billion in December 2013.

The Wall Street Journal reported that Walgreen's same store sales increased by 7.5% in June. During the same period, Rite Aid Corp (NYSE:RAD) reported that same store sales increased by 3.5%.

Walgreen and Family Dollar sell many of the same products at similar prices. Yet Walgreen and CVS Caremark offer a variety of services that Family Dollar does not, including a pharmacy and money orders.

The same stores at Walgreen are being driven by increased pharmacy use. If the price for toilet paper and shaving cream at Walgreen and Family Dollar is pretty much the same, the customer has no incentive to shop at Family Dollar. Instead, he or she can eliminate the hassle of going to Family Dollar by simply buying those things while picking up his or her prescriptions at Walgreen or CVS.

Walgreen and CVS Caremark simply have a better business model than Family Dollar and Dollar General. Prescription drugs give them a moat that also attracts additional business to the store. Both chains are also placing more emphasis on consumer goods as the popularity of generic drugs cuts into profits from prescriptions.

Like Family Dollar and Dollar General, the drugstores operate convenient locations in neighborhoods that people can run in and out of fast. They also benefit from rising gas prices, which prompt people to make fewer trips and avoid longer journeys to big box stores.

Dollar Store Bloodbath Coming Fast

My guess is that the dollar store bubble has burst and we're about see some serious bloodletting at both Family Dollar and Dollar General. Dollar General's revenues are rising for now but rising slowly; like Family Dollar, it has expanded too much and too fast.

The situation will only get worse as Wal-Mart Stores Inc. (NYSE:WMT) rolls out more Walmart Express stores around the country. Although they've been touted as dollar stores, most Walmart Express stores are really neighborhood drug stores containing pharmacies. Some Walmart Express stores will also offer groceries and gas pumps, which make them even more convenient than the drugstores.

Contrary to popular belief, Walmart Express stores are designed to compete with Walgreen and CVS Caremark, not Family Dollar and Dollar General. In addition to gasoline, Wal-Mart can offer a wide variety of financial services the drugstores don't, including auto insurance in some states.

Expect to see massive numbers of store closings at both Family Dollar and Dollar General if they get caught in the middle of a war between Wal-Mart and drugstore operators. Wal-Mart and CVS Caremark have vast amounts of cash to spend; neither Family nor Dollar General does.

As I pointed out above, Family Dollar reported $10.47 billion in revenue compared to CVS's $128.69 billion and Walgreen's $75.28 billion. The dollar store operators are having a tough time contending with those resources, even as a competitor with $477.3 billion in revenue - Wal-Mart - is entering the market.

It looks like dollar stores simply lack the kind of moat needed to survive in today's retail environment. Their business model of selling limited inventories at a low price just doesn't seem to be cutting it in today's hyper competitive retail environment. The nation will soon be dotted with empty Family Dollars and Dollar Generals.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.