Merrill Lynch Sours on Dollar Stores Theme

Shareholders of Family Dollar Stores Inc. (NYSE: FDO) voted on January 22 to approve the merger with Dollar Tree Inc. (NASDAQ: DLTR). As a result, Merrill Lynch has come forth and removed Family Dollar’s rating, as it is no longer trading on the fundamentals. The brokerage firm said that Dollar Tree’s synergies were discounted but not its integration risks, and so Dollar Tree was given a Neutral rating.

Dollar Tree was given a price objective of $80, with the rationale that while its earnings momentum has been impressive, the firm thinks these positive trends could be overshadowed by Family Dollar. Dollar Tree has acquired and integrated other companies before but not on the scale of Family Dollar.

On the other side, Dollar General Corp. (NYSE: DG) is considered to be in the doghouse with few catalysts, and the company was given an Underperform rating. It has been up 25% since Dollar Tree announced its bid for Family Dollar, but management has few options besides delivering exemplary results, and this has not been the case recently.

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Dollar General was given this Underperform rating by Merrill Lynch for six reasons:

  • After a major strategic misstep (failure to acquire Family Dollar), Merrill Lynch believes management has few options for winning back investor confidence apart from delivering superb operating results, which has not been the case over the last few quarters
  • A fourth-quarter earnings miss is possible (consensus comp is 5.1% vs. the firm’s 4% est), and without a deal pending, the focus will be back to fundamentals
  • Street estimates for 2015-16 look aggressive given muted comps and SG&A deleverage and [general merchandise] pressure
  • Dollar General underperformed while its competitors were distracted and Family Dollar in particular performed poorly, so we have little confidence that it can outperform sharper competitors going forward
  • Competitively, Dollar General now faces a three-front war between Wal-Mart Stores Inc. (NYSE: WMT), Dollar Tree and Family Dollar
  • Limited room for increased leverage and capital return if Dollar General intends to remain Investment Grade

Shares of Family Dollar were down less than 1% at $76.37 in midday trading Monday. The stock has a consensus analyst price target of $72.65 and a 52-week trading range of $55.64 to $80.97.

Shares of Dollar Tree were down 3% at $69.90. The consensus price target is $72.41. The 52-week trading range is $49.59 to $72.59.

Dollar General shares were down nearly 1% at $68.97. The consensus price target is $75.50, and the 52-week trading range is $53.00 to $71.78.

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