Why Walmart, Target Lose in Family Dollar Saga

Advertisement

No matter how the Family Dollar (FDO) saga plays out, one thing is clear: A bulked-up dollar store chain is bad news for Walmart (WMT) and Target (TGT), which have been struggling for months to attract shoppers into their bricks-and-mortar stores.

family dollar general, walmart, targetFamily Dollar received a sweetened $9.1 billion offer from Dollar General after DG’s earlier offer was rejected by the smaller company because of antitrust concerns in favor of an $8.5 billion by Dollar Tree (DLTR). Dollar General’s offer is too enticing to pass up. It agreed to sell as much as 1,500 locations to appease regulators … though, given some recent antitrust like Office Depot’s (ODP) purchase of Office Max, those sales may not be necessary.

To sweeten its offer even further, Dollar General has agreed to pay Family Dollar a $500 million breakup fee if regulators reject it on antitrust grounds.

The Dollar Store Saga Continues

A research report released today by Wolf Research’s Scott Mushkin argues that a combined Dollar General-Family General would post the most formidable threat to Walmart. Dollar General has 11,500 locations in 40 states and Family Dollar has 8,100 stores in 46 states. If the chains combine, they would be able take a page from Walmart’s playbook and negotiate better prices from suppliers.

Dollar General will spend whatever it takes to get Family Dollar. It has no other choice given that it generated lackluster earnings in the most recent quarter even as it offered more discounts and sold more lower-margin products such as tobacco. BB&T Capital Markets analyst Anthony Chukumba described Family Dollar as a “must-have” for DG.

Dollar General shares are also attractively valued and offer a decent reward given the potential risk. They trade at a price-to-earnings multiple of 19.45, which near its 5-year-low of 15.60. Wall Street analysts have an average 52-week price target of $71.39, about 12% above where it recently traded.

Family Dollar has struggled lately, and whoever buys it would welcome the chance to ditch underperforming stores even if regulators don’t insist on divestitures. As the The Wall Street Journal noted, same-store sales — a key retail metric — have averaged 1.6% growth over the past three quarters, down from 6.5 percent over the prior 23. Its rivals have done much better. Dollar General posted a same-store sales gain of 2.1%, buoyed by strength in home goods and apparel, while DollarTree reported a 4.4% increase.

Walmart and Target Feel the Pressure

Walmart and Target have fared far worse than their dollar store brethren. U.S. Walmart stores have posted an unprecedented five straight quarters of negative same-stores sales. Traffic has fallen for the past seven quarters. Target recently reported flat same-store sales in the U.S. and a staggering 11% drop in Canada, where many retailers have struggled.

Both chains have repeatedly blamed economic pressures on low-income shoppers for their problems. While that certainly is a factor, Wall Street hasn’t overlooked the fact that dollar stores seem to be performing better than the two biggest chains.

Walmart and Target have overhauled their management teams in recent months. New Zealand native Greg Foran recently became the head of Walmart’s U.S. stores. Earlier this year, Doug McMillan was named CEO, replacing Mike Duke. Target ousted veteran CEO Greg Steinhafel earlier this year after the chain botched a massive data breech. Brian Cornell replaced him.

The grocery business is an integral part of the growth strategies of both WMT and TGT. Unfortunately, that business remains the strength of the dollar stores, which appear to be gaining market share at the expense of the big box operators. According to IBISWorld, groceries will account for about 22.4% of the sector’s revenue in 2014. That percentage has expanded over the past 5 years as companies have added more products to their inventory, including many national brands.

Walmart has tried to counter the sector’s growth by adding smaller-format “Neighborhood Markets” and plans to more than double these locations. Shares of WMT have slumped about 3% in the year-to-date, while TGT has fallen about 5%. A bigger dollar store operator will siphon away shoppers from both chains, further pressuring margins. That’s reason enough to avoid both stocks.

As of this writing, Jonathan Berr did not hold a position in any of the aforementioned securities.

Jonathan Berr is an award-winning freelance journalist who has focused on business news since 1997. He’s luckier with his investments than his beloved yet underachieving Philadelphia sports teams.


Article printed from InvestorPlace Media, https://investorplace.com/2014/09/family-dollar-general-walmart/.

©2024 InvestorPlace Media, LLC