A familiar story surfaced in the world of discount retail stocks yesterday morning when Family Dollar (FDO) reported earnings. Earnings per share fell short of the consensus by one penny, and FDO stock got crushed early as a result.
Shares of Family Dollar stock initially slid more than 7% from Wednesday’s closing price of $66.34, all the way down as low as $60.89. FDO did regain some ground during the afternoon to finish at $64.97 — a one-day loss of 2%.
Family Dollar earnings tallied 68 cents per share — again, a penny short of what the Street had slated. And while revenue was up 3.2% to $2.5 billion, that also fell short of expectations.
Of course, what rattled Family Dollar stock investors the most was the company’s lowered guidance. FDO issued EPS guidance for the second quarter of 85 cents to 95 cents vs. the $1.21 consensus. It also issued downside EPS guidance for the 2014 fiscal year, expecting $3.25 to $3.55, as opposed to the $3.80 to $3.98 consensus.
In addition, Michael Bloom, the President and COO of Family Dollar, announced his resignation. All of this led to speculation that FDO could be bought by one of the other discount retailers, and that helped put prop up the Family Dollar stock price as the day went on.
Of course, this is not the first time that Family Dollar has been seen as a possible takeover target. In 2011, FDO rejected a $7.75 billion offer from Trian Partners, a fund run by investor Nelson Peltz. Trian, the second largest shareholder of Family Dollar stock, entered into an agreement with the company in 2011 to halt any further push for a sale.
But that agreement ended in 2013, and so it’s possible that Trian could once again be in the market to acquire FDO. The company has also dropped its resistance to allowing Trian to acquire a stake larger than the current 7% it has in Family Dollar stock.
Another bid for the company could also come from Paulson & Co., which owns the largest stake in the retailer at just less than 10% of Family Dollar stock.
How to Play Family Dollar Stock Now
If you’re pondering how to play FDO now, it helps to look at some of its rivals. Of course, trading in the other discount retailers was mixed. Dollar General (DG) stock also took a hit on the FDO news, down 0.63%, while Dollar Tree (DLTR) was up 0.12% on the day and Walmart (WMT) was up 0.33%.
But it was a year ago this week when I previously reported on FDO stock getting a severe beat-down for coming in at the lower end of earnings estimates. And it was only about six weeks ago that DLTR stock was handed a similar fate for missing estimates.
The interesting thing about discount retail stores like Dollar Tree and Family Dollar is that they always seem to rebound handily over the next 6 to 12 months after a beat-down. Thus, they become great bargain stocks when purchased on these pullbacks.
Of course, fans of Family Dollar stock should note that it usually takes about six to eight weeks for these picks to completely form a base before beginning their next ascension.
For example, on Nov. 21, 2013, DLTR stock got hammered from $59 to just above $56 on a missed earnings report. Over the last seven weeks, DLTR stock has traded completely flat, setting up a new base. And considering, Dollar Tree — with its “Everything $1″ superior business model — has demonstrated formative relative strength to both Family Dollar and Dollar General in the past, I would expect that to continue going forward. I therefore expect DLTR stock to break out of that base fairly soon.
Click to EnlargeWhich brings us back to FDO. As the accompanying chart (from Stockcharts.com) shows, after Family Dollar stock was hammered in early January, it spent the next 12 months climbing from $55 to $75 a share — a gain of 36%.
Therefore, given the possibility of a takeover of Family Dollar by one of the aforementioned hedge funds or another discount retailer, and given the strong durability of these discount retailer stocks to bounce back over time, Family Dollar stock becomes a stock to own on any further pullback near the lows set this morning around $61.
At worst, there is strong support for FDO stock from last summer at $59 per share. But should a takeover occur, or if FDO just follows the typical pattern of these discount retailer stocks, Family Dollar stock could easily climb back up into the $74 range, where it peaked in September of 2013.
As Yogi Berra, the baseball legend once observed, “It’s like Déjà vu all over again!”
As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.