- Family Dollar’s revenue expanded slightly due to the opening of stores, but net income and free cash flow declined.
- Family Dollar’s low debt balance sheet serves as a small bright spot.
- Family Dollar’s dividend hasn’t been sustained by free cash flow for three years.
On Jan. 8, dollar discount chain Family Dollar (NYSE: NYSE:FDO) came out with its Q1 FY 2015 earnings announcement. The company performed terribly. Let's take a look to see what's going on with the company.
Revenue expanded slightly
In the most recent quarter, Family Dollar saw its sales increase 2.3% year-over-year. This is mostly due to the opening of new stores. Family Dollar saw its same store sales drop 0.4% giving indication that it's having a hard time getting customers to come through the doors. Driving sales and profitability through expansion is one thing. However, the company needs to make sure its established network of stores keep customers happy.
Net income declined
Family Dollar's net income declined a whopping 47% as it continues to lower prices on its merchandise to meet the competition. Also, its questionable strategy of introducing lower margin "consumables" into its merchandise line up, such as tobacco and food, served as a drag on net income. Family Dollar needs to figure out how to cater to consumers' increasing health consciousness rather than going against that trend. Also, merger fees pertaining to possible mergers served as a drag on net income.
Free cash flow negative
Family Dollar's free cash flow deficit expanded 127% due to the timing of the payments toward its accounts payable which suggests that this may be a temporary seasonal thing. Hopefully, Family Dollar will be free cash flow positive for the full year.
Decent balance sheet
Family Dollar maintains a decent balance sheet. Its $213 million in cash and short-term investments equates to 13% of stockholder equity in the last quarter. My personal preference is that companies maintain a cash balance equating to 20% or more of stockholder equity to get them through tough times. Family Dollar's long-term debt also equates to 18% of stockholder equity which lies below my personal threshold of 50%. Long-term debt creates interest which chokes out profitability and cash flow. In the most recent quarter, Family Dollar's operating income exceeded interest expense by nine times. The rule of thumb for safety lies at five times or more.
Dividends not sustainable
The best way to gauge dividend sustainability is to compare how much a company's free cash flow it pays in dividends. Since Family Dollar was free cash flow negative in the most recent quarter it stands to reason that the quarterly dividend payment was supported by its free cash flow. In FY 2014, the amount paid out in dividends amounted to 393% of free cash flow. According to Morningstar, Family Dollar also was free cash flow negative in FY 2012 and FY 2013 meaning the dividend was not backed by free cash flow in those years either. Currently the company pays its shareholders $1.24 per share per year and yields 1.6% annually.
Until Family Dollar gets it act together on its merchandise strategy, customer engagement and free cash flow investors should stay away. Selling tobacco in the face of declining demand due to health concerns doesn't sound like a good idea. Paying a dividend with miniscule to negative free cash flow doesn't sound prudent either. Finally, Family Dollar trades at a P/E ratio of 32 vs. 19 for the S&P 500 and 21 for Family Dollar's five-year average, making it overvalued in addition to its lousy fundamentals. There are better fish in the sea for your investing dollars.
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