I’ve followed the dollar stores for quite some time, and all along, my favorite pick has consistently been Dollar Tree (NASDAQ:DLTR). However, when hedge fund manager Bill Ackman purchased a ton of shares of rival Family Dollar (NYSE:FDO), it got my attention. I decided to see if Family Dollar might be improving on all the metrics it always lagged in and if it was becoming a compelling buy.
Recently released fiscal Q1 earnings were encouraging, with diluted earnings up 17% on a 7.6% increase in total sales and a 4.1% rise in comparable-store sales. Gross margin improved to 6.3% from 6.1%. That’s all good.
But the real news is what’s going on with the product mix, because it not only tells us a lot about Family Dollar and where it’s headed, but about another sector.
Like other dollar stores, Family Dollar is moving aggressively into consumables, i.e. food. The numbers are robust. Comparable-store sales in this sector rose a strong 11.4%. Family Dollar has boosted inventories by 14% to account for this new focus. The company will add 300 new food items, including 100 private-brand items. Food now makes up 70% of the chain’s sales.
Why the move into food? “Our core customer is still very stressed. . . . When faced with the question of what am I going to have for dinner versus buying a new shirt, our customers pretty quickly figure out what’s most important,” CEO Howard Levine said in the conference call.
Family Dollar is merely grabbing at the same market that has helped McDonald’s (NYSE:MCD) sales and earnings take off during the financial crisis. It’s a great strategic move, and it’s paying dividends. Since many dollar store food offerings are brand names customers are familiar with, it makes all the more sense to stock the shelves with food.
Mind you, Family Dollar still has some work to do to catch up with my frontrunner, although it’s cheaper (13x earnings vs. 17x earnings for Dollar Tree). However, the new product mix plus spending serious money on renovating may be the jump-start it needs.
Who’s the loser in this scenario? The grocers. As if companies like Safeway (NYSE:SWY) didn’t have enough trouble fighting off other grocers, now they have to compete with the dollar stores.
We’re starting to see the fallout from this strategy, as Food Lion is closing 126 stores, partially because of this increased competition. And grocers have to get by on net margins of 1.5% or less, whereas the dollar stores enjoy margins of 4% to 7.5%.
Who’s next to get slapped? The fast food industry? It’s possible. If people discover they can get a more traditional meal at the dollar store rather than fast food at McDonald’s for the same price or less, Ronald McDonald may not be such the happy clown in the near future.
Lawrence Meyers does not own shares of any company mentioned.