The economy is still in doldrums, and bargain hunters are going from one shop to another to grab the best deal, with their primary focus being on consumable items. Family Dollar Stores Inc. ( FDO ), with its low cost options, remains successful in luring cautious consumers amid the economic gloom. However, margins remain under pressure.
Family Dollar offers general merchandise in four categories--consumables, home products, apparel and accessories, and seasonal and electronics--and sells merchandise at prices from under $1 to $10.
What the Company Counts On
The company's strategic initiatives to improve merchandising, marketing and store operations have resulted in sustained growth in the top and bottom lines. Management now expects a growth of 8% to 10% in net sales and an increase of 12.2% to 20.2% in earnings per share in fiscal 2012.
The company remains committed towards better price management, cost containment efforts, effective inventory management, private label offering and expanded operating hours that should augur well for sales. Moreover, in order to enhance the market share, Family Dollar intends to focus on both consumables and discretionary categories.
The company has also been making prudent investments related to store infrastructure; store openings, expansions and relocations; and improvement of distribution centers to drive revenue growth.
All these initiatives helped Family Dollar to post healthy first-quarter 2012 results. The quarterly earnings of 68 cents a share came in line with the Zacks Consensus Estimate, and jumped 17.2% from 58 cents earned in the prior-year quarter on the heels of healthy sales witnessed in the Consumables, and Seasonal and Electronics categories.
North Carolina based Family Dollar now expects second quarter earnings between $1.10 and $1.18. However, the company reiterated its fiscal 2012 earnings of $3.50 to $3.75.
The operator of self-service retail discount store chains posted a 7.6% increase in revenue to $2,148.3 million from the prior-year quarter, and reflected sales growth across Consumables (up 11.4%) and Seasonal and Electronics (up 5.6%), offset by Apparel and Accessories (down 3.4%) and Home Products (down 2.8%). However, total revenue fell short of the Zacks Consensus Estimate of $2,166 million.
Margins Under Pressure
Family Dollar registered growth in the top and bottom lines, but that was not enough to alleviate the concern about increasing gross margin pressure. It was apparent that the growth in the top line was led by lower-margin consumables category, which now accounts for 70.3% of total sales compared with 67.9% in the prior-year quarter. Consequently, the increase in sales of lower margin merchandises weighed upon the company's gross margin that contracted 70 basis points to 35.3%.
It is obvious that given a dismal economy, consumers will focus on basic necessities such as food, which generally carry lower margin. Management now expects gross margin in the second quarter of 2012 to be somewhat in line with the first quarter. For the year, management expects gross margin to remain under pressure.
Moreover, the company's customers remain sensitive to macroeconomic factors including interest rate hikes, increase in fuel and energy costs, credit availability, unemployment levels, and high household debt levels, which may negatively impact their discretionary spending, and in turn the company's growth and profitability.
Challenging Economy & Competition
The economy is still not out of the woods, and consumers will remain cautious on their spending, buying only those things that fulfill their basic needs. Consequently, we could see more competitive pricing and new products to attract shoppers. A trigger in price war will definitely eat away margins, which in turn will affect the company's results. In order to remain competitive, it is better to try out innovative ways to win the heart of target consumers rather than fading away in an unhealthy contest.
Family Dollar operates in the highly competitive discount retail merchandise sector. Peer pressure from the likes of Wal-Mart Stores Inc. ( WMT ) and Dollar General Corporation ( DG ) will likely continue to weigh on its results.
Holds Zacks #3 Rank
Given the pros and cons embedded in the stock, we maintain our long-term 'Neutral' rating on the stock. Furthermore, Family Dollar shares maintain a Zacks #3 Rank that translates into a short-term 'Hold' recommendation and correlates with our long-term view.