Why Wal-Mart Will Not Buy Family Dollar

Sep. 2.14 | About: Wal-Mart Stores, (WMT)

Summary

Family Dollar's revenues are too small to justify the cost of an acquisition by Wal-Mart.

Family Dollar's stock is overpriced.

Family Dollar would not be a good fit with the Wal-Mart Express business model, because it lacks gas pumps and pharmacies.

Family Dollar's low-income customers are not the shoppers Wal-Mart needs or wants.

Wal-Mart needs more middle- and upper-income customers, who are deserting it for Costco and Amazon.com.

A lot of investors are surprised because Wal-Mart Stores Inc. (NYSE:WMT) decided not to bid for Family Dollar Stores (NYSE:FDO), which is essentially selling itself to Dollar Tree Stores (NASDAQ:DLTR) right now. Those investors should not be surprised, because it makes little or no sense for Wal-Mart to buy Family Dollar.

There are several very obvious reasons why Wal-Mart's management team does not want to touch Family Dollar. Two of these criteria seem to stand out as the main motivation for the decision:

  • Family Dollar is so small that it simply would not do a lot for Wal-Mart's bottom line. Family Dollar reported a TTM revenue figure of $10.38 billion on April 30, 2014. Wal-Mart's TTM revenue grew by $8.49 billion between April 2013 and April 2014, rising from $468.81 billion to $477.30 billion. Wal-Mart is still growing without Family Dollar.
  • Family Dollar's stock is overpriced. On August 29, 2014, it was trading at $79.83 a share. That seems awfully high for a retailer that saw a six percent drop in revenue earlier this year. In November 2013, the discounter's TTM revenue reached an all-time high of $10.47 billion. By February 2014, it had fallen to $10.29 billion. Family Dollar has also announced the closing of 370 stores.

Basically, Family Dollar is oversized, overvalued, and losing money; that's why the management team is anxious to sell out. It is easy to see Wal-Mart is not going to go near it for financial reasons.

Family Dollar Does Not Fit In with Wal-Mart's Business Model

Revenues are not the only reason why Wal-Mart is staying away from Family Dollar. The small-box discounter simply does not fit in with the retail giant's business model for its Wal-Mart Express small-box stores.

Wal-Mart Express's real target is drugstore operators like Walgreen (WAG) and CVS Caremark (NYSE:CVS), which have fast-growing revenues. Walgreen reported a TTM revenue of $75.28 billion on May 31, 2014, and CVS reported a TTM revenue of $132.04 billion on June 30, 2014. Wal-Mart wants a piece of the drugstore operators' business, and it is easy to see why they are making a lot of money.

To compete with drugstores, Wal-Mart Express will offer a lot of things that Family Dollar does not. This includes pharmacies, large selections of groceries, financial services such as check cashing, and even gas pumps. Were Wal-Mart to buy Family Dollar, it would have to spend big money adding services to existing stores. It would have to effectively rebuild each Family Dollar location to offer prescriptions or vegetables.

It makes more sense for Wal-Mart to simply build new stores with the Wal-Mart brand on them. By constructing new locations, Wal-Mart will also be in a position to put in gas pumps and slightly larger stores with more storage.

Wal-Mart Does Not Want Family Dollar's Customers

The one thing Wal-Mart wants less than Family Dollar is the dollar-store operator's customers. Family Dollar's customer base is the suburban and rural poor, a group that is heavily dependent upon government benefits such as food stamps.

During the fourth quarter of 2013, Wal-Mart's net income fell by 21%, largely because of a $48 billion cut in food stamp benefits and the end of a payroll tax break. The big retailer learned the hard way that dependence on lower-income customers is a good way to lose a lot of money fast.

If it is to see its revenues start growing again, Wal-Mart will need to lure in middle and upper class shoppers, or at least get them back. In recent years, such shoppers have been deserting the giant for more convenient alternatives, such as Costco Wholesale (NASDAQ:COST), Amazon.com Inc. (NASDAQ:AMZN), Kroger (NYSE:KR), and drugstores. These retailers have learned how to match Wal-Mart's prices and offer a better or at least more convenient shopping experience.

Wal-Mart Express is designed to appeal to middle class shoppers - mostly busy soccer moms - by offering one-stop shopping for gas, groceries, toiletries, cleaning supplies, and prescriptions. Wal-Mart's recent push into online retail and experiments with delivery are also designed to win back such customers.

Wal-Mart does not want Family Dollar's customers. It wants Amazon.com's customers and Costco's customers, because they are the people with the money.

A Retailer That Wal-Mart Might Actually Buy

Even though it has no interest in Family Dollar, there is at least one major retailer that Wal-Mart might acquire: America's third-largest drugstore chain, Rite Aid (NYSE:RAD). Rite Aid is currently very cheap; on August 29, 2014, its stock was trading at $6.22 a share, yet it operated 4,623 stores nationwide as of March 2013.

Despite its low price, Rite Aid reported a TTM revenue of $25.7 billion, or more than twice that of Family Dollar, on May 31, 2014. Rite Aid also has a very strong position; it is considered the largest drugstore chain on the East Coast.

Rite Aid's business model, which combines a small-box discount operation with a pharmacy, is closer to Wal-Mart Express than Family Dollar. It might also be easier to integrate with Wal-Mart. Rite Aid's major competitors are CVS Caremark and Walgreen, two chains whose business Wal-Mart wants a bigger piece of.

It doesn't look like Wal-Mart is shopping for brick-and-mortar acquisitions right now (it's concentrating on online), but if it were, Rite Aid would be a more logical purchase than Family Dollar. Rite Aid might fit into Wal-Mart's current business plans; Family Dollar would not.

Disclosure: The author is long KR.

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.

Additional disclosure: The author conducts some retail sales through Amazon.com.