Analyst Downgrading Dollar Store Theme (FDO, WMT)

March 28, 2012 by Jon C. Ogg

Family Dollar Stores, Inc. (NYSE: FDO) may be trading up after its earnings, but there is a call of caution that needs to be highlighted.  Bank of America Merrill Lynch has downgraded the dollar store chain to “Neutral” from “Buy” and it lowered the price target down to $60 from $67 in the call.  If the logic is correct, Family Dollar is effectively at or very close to a fully valued story.

Dollar stores are supposed to be the secular growth theme for retail in the decade ahead.  The companies have reached up into some higher priced goods as food products and other products are being made cheaper for consumers at the same time that millions of consumers have had to reach down in price.  Another concern in the downgrade is that Wal-Mart Stores Inc. (NYSE: WMT) is a threat as it plans to accelerate its Express store openings.

The downgrade from BofA/ML is effectively over execution concerns after th company’s earnings were below expectations.  The report even noted that this was the fifth consecutive quarter that Family Dollar reported comparable sales that were below or at the low end of management’s guidance.

The good news for investors playing the secular growth theme of this retail segment is that BofA/ML noted as a contrast that peers have benefitted from industry strength and internal initiatives.  The peers have also been beating same store sales expectations.  It was further noted that Family Dollar is not fully leveraging its own internal initiatives at this point.  Another concern was rising inventories with a gain of 15.4% total and up 11% per store.  Markdown fears are rising and the report bases the price target reduction as now being based on 17-times 2012 earnings estimates rather than 18-times.

Whether this is a secular growth segment or not, investors should be asking if they should really be paying 17-times or 18-times earnings for a broader sector that trades at lower earnings multiples.

Family Dollar Stores shares are trading up 1% at $58.84 against a 52-week trading range of $44.42 to $60.53.  Thomson Reuters has a consensus price target objective of $60.45 on this stock.

JON C. OGG