I finally came up with a somewhat appropriate analogy for the
) battle in the dollar-store arena:
) vs. the other supermarket chains -- such as
) -- about a decade ago.
Ten years ago Kroger realized that, like the proverbial one of two
campers running from the bear, it did not have to outrun the bear,
only the other camper. So it cut its untenably high prices vs.
(WMT) and gained market share and operating leverage as the other
supermarkets maintained their prices and margins. Kroger is now in
a somewhat stable position vs. Wal-Mart's supercenters, while
Safeway and SuperValu are not.
As background, I refer readers to my last two notes:
Wal-Mart's Neighborhood Markets Pose Threat to
Family Dollar Stores: The Prices Are Too High,
and So Is the Stock.
I have argued that FDO's prices, at 3%+ over Dollar General, are
too high. Consistently disappointing same-store sales numbers at
4-5% below DG's results over the past two quarters have borne that
out. That price differential, I have stated, will cause FDO to be
very disadvantaged against competition from Wal-Mart's Neighborhood
Markets and the Wal-Mart Express concept in the next three to four
Now, looking at Wal-Mart data from its recent investor conference
in Arkansas, Family Dollar -- and to a lesser extent, Dollar
General -- will be facing a much tougher competitive environment
faster than I expected. My worst-case scenario was that a
Neighborhood Market (NM), typically 35-40,000 square feet, would
displace six dollar stores, at 8-10,000 square feet per outlet.
Wal-Mart told analysts recently that the NM format equals 10 dollar
stores in terms of sales. While I did not estimate how many dollar
stores would be displaced by Wal-Mart Express, because the company
did not previously stress growth in that area, I did expect that
stores opened by another competitor, Aldi, would displace 1.5 times
the dollar store square footage. My expectation was low again --
way low. Wal-Mart said that each Walmart Express outlet, at about
15,000 square feet, sells as much as three to five dollar stores,
and that's with prices about 4%
Wal-Mart also announced that it was accelerating NM expansion and
expected to open more than 700 stores by fiscal year 2017; a
previous estimate suggested it would open 500 stores by 2016. The
company also said that Neighborhood Market stores are extremely
effective versus dollar stores because Wal-Mart's outlets have a
pharmacy, and because they offer a wider assortment of products at
lower prices. I would look for next year's meeting to reveal some
big expansion numbers on the Wal-Mart Express concept, which is
only 20 units now.
This quote is from my the article mentioned above on dollar store
Assuming that dollar store square footage grows at a 6.5% growth
rate, and using a displacement of four dollar stores by one
Neighborhood Market, I found that the saturation level is reached
two years earlier, in calendar 2015, instead of 2017 where it would
have reached saturation without an increase in dollar stores.
In the 'worst case' scenario, if a Neighborhood Market were to
displace six dollar stores, the saturation point would come almost
another year earlier.
Adjusting this expectation for the much stronger threat that
Wal-Mart's smaller concepts seem to be, I would expect secular
pressure on Family Dollar's stores to show up in calendar year
2014, and certainly by 2015.
Therefore, what is in the valuation?
Well, if I am right, the $4 estimate for FY14 ending in August
could be high, and the Street low of $3.65 for FY15 looks to be a
better bet than the consensus of $4.45. If an expansion into
California by FDO goes very well, maybe it gets to 2015 before the
competitive pressure (saturation point) is reached.
Looking at a three-stage earnings discount model and giving Family
Dollar the benefit of the doubt on earnings with the $4.45 Street
consensus for FY Aug '15, I use the 11% growth rate from FY14 to
FY15, then decay the growth rate in FY16 for the competition. The
result is a $47 deserved valuation.
Keep in mind that the differences in sales per square foot, if they
hold up, will force FDO to lower its pricing structure in the next
three to four years with a hit to the present value of future
earnings, something I am not accounting for in my valuation