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Family Dollar — How to Play Wednesday’s Earnings Report

Performance and takeover speculation will buoy FDO


Discount retailer Family Dollar (NYSE:FDO) reports earnings for the quarter ending Aug. 31, 2011, on Wednesday. The report is likely to show growing revenue and profits at a time of great distress for many consumers.

The bigger story for Family Dollar is the continued possibility of a buyout. Early in the year, the company received an unsolicited offer from hedge fund manager Nelson Peltz. Management ultimately rejected that offer, but speculation continues that a sale is imminent.

One possible buyer would be Dollar General (NYSE:DG). That synergistic deal, should it come to pass, would create a dominant player in the dollar deals space — a space that is likely to see continued growth given current softness in the economy.

Earnings at Family Dollar have been mixed, with the company missing Wall Street estimates in two of the past four quarters:

Family Dollar

Given the performance in the prior quarter, Wall Street estimates for the period ending Aug. 31 have dropped by two cents per share during the past 90 days. The current expectation is for the company to make 63 cents per share in the quarter. Aug. 31 also marks the end of the fiscal year for Family Dollar. For the full year, Wall Street expects the company to make $3.09 per share.

In the coming fiscal year, Wall Street estimates a profit of $3.58 per share. That would be a 16% increase over the last fiscal year. At current prices, Family Dollar trades for 15 times forward earnings.

Shares have held steady near the Peltz offer of $55 to $60 per share since the offer was made. Shares did dip in early March after the company rejected the offer but quickly recovered, then the stock traded sideways until mid-July. At that time, shares sunk with the rest of the market. The losses were temporary, and the stock quickly rebounded to its current price of $54 per share.

During the past year, FDO shares have gained 25%:

Family Dollar

Earnings certainly are important, but the speculation about a takeover has greatly impacted Family Dollar’s share price since early in the year. Shorts are betting against a deal being done and longs are buying FDO thinking a buyer will pay a bigger premium for the stock than the previous offer.

In addition to Peltz, Family Dollar has attracted the interest of activist investor Bill Ackman. In June, Ackman’s Pershing Square announced it had boosted its stake in Family Dollar to 8.9%. At the time of that disclosure, Ackman seemed content on being a silent owner with the expectation of the company growing and the stock appreciating.

Given the slippage in the economy, Family Dollar would seem to have the wind at its back. I would expect the company to beat the lowered Wall Street estimate for profits this quarter. Strong operating performance combined with the possibility of a takeover will have investors cheering. The stock could push its way to $60 after it reports results Wednesday.

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