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Family Dollar's Snow Job Melts Under Scrutiny

NEW YORK (The Deal) -- Discount chain Family Dollar Stores  (FDO - Get Report) said Thursday it will close 370 stores, scale back new store openings and lay off workers after reporting disappointing results.

Net sales for the company's second quarter, which ended March 1, declined to $2.7 billion from $2.9 billion for the same period a year prior, while net income fell to nearly $91 million versus about $140 million for the same period a year ago.

Family Dollar noted, however, that the quarter included 13 weeks as opposed to the 14 weeks that comprised the similar quarter a year ago, with the extra week constituting nearly $190 million in sales and 7 cents of earnings per share. The company also blamed the weather for the poorer results, reducing earnings per share by another 5 cents.

"The 2013 holiday season was challenged by a more promotional competitive environment and a more financially constrained consumer. In addition, like many retailers, our second quarter results were significantly impacted by severe winter weather, which resulted in numerous store closings, disrupted merchandise deliveries and higher than expected utility and store maintenance expenses," said Howard Levine, Family Dollar's chief executive, in a statement.

But there is obviously more to Family Dollar's story than just the loss of a week and too much snow. The store closures, workforce reductions and shrinking ambitions for new stores are likely the products of longer-term problems. Industry watchers suggest the company is not being run as well as some of its competitors.

In addition, the decline in earnings occurred despite a reduction in capital expenditures to nearly $220 million during the first half of fiscal 2014 from nearly $410 million in the prior year period. The company said it will conduct a review of its business to improve operations and financial performance.

"Notwithstanding the macro-economic pressure, competitive environment and severe weather, we are not satisfied with our results, and we hold ourselves accountable for improving our performance," Levine said. "To that end, we have initiated an in-depth business review to identify opportunities to strengthen our value proposition, increase operational efficiencies and improve financial performance."

The company said it expects the store closings and layoffs to boost annual operating profit by an estimated $40 million to $45 million, Levine said.

As a result of the moves, the discount chain will take an estimated $85 million to $95 million restructuring charge in the second half of fiscal 2014 not reflected in previous guidance.

Lastly, Family Dollar plans to open 350 to 400 new stores in fiscal 2015, versus the roughly 525 new stores it will unveil in fiscal 2014. The dollar chain will also lower prices on about 1,000 basic items sold in its stores, he said.

The retailer's overall outlook for fiscal 2014 includes a low-single-digit increase in revenue and comparable store sales, along with a decline in gross profit as a percentage of sales.

In light of such performance and guidance, industry watchers said Family Dollar should consider a combination with a competitor such as Dollar General (DG - Get Report), with a market cap of about $17.5 billion, or one of the other dollar-themed chains. One observer suggested that Dollarama of Canada could look to expand in the U.S. via a combination with a U.S.-based chain. Family Dollar has a market cap of nearly $6.6 billion, while Dollarama has a market cap of nearly C$6.4 billion ($5.85 billion).

A Dollar General press official said the company does not comment on speculation.

Family Dollar and Dollarama did not respond to a request for comment.

Unlike specialty retailers, one source noted, dollar-themed chains are more attractive because of their real estate. To expand across a region, specialty retailers would just have to rent spots in more malls. Discounters have to find appropriate locations and, often, construct new buildings.

Family Dollar, in particular, has a strong presence in the Southeast, and comes up about once a year as a potential target, the source said.

But the discount chain has been resistant in the past to buyout pressure, turning down an offer from Nelson Peltz's Trian Fund Management. Trian offered a cash price of $55 to $60 per share, or $6.6 billion to $7.2 billion, for the company in March 2011.

Peltz ended up withdrawing the offer in exchange for a board room presence. His hedge fund continues to hold a 7.35% stake as of Jan. 16.

Levine, who is the son of Family Dollar's founder, held a 8.18% stake in the company as of Oct. 15. "It is a controlled situation," a source pointed out, with a large insider stake. Paulson & Co. holds an 8.58% stake as of Dec. 31.

Because the company's problems run deeper than the weather, one source suggested that Family Dollar might be weakening to the point at which it is no longer an attractive target. That concern would be especially acute if the chain were compelled to lower prices as a way of staying with its rivals. That person said if Family Dollar loses too much market share, the competition will "begin working around" Family Dollar, opening stores nearby, rather than pursue a deal.

According to data provided by Bloomberg, the company had nearly $800 million in debt, and about 
$170 million in cash. Ebitda is expected to drop this year to nearly $860 million for the year ending Aug. 31, compared to the nearly $930 million in Ebitda generated for the last fiscal year, which ended Aug. 25, also according to Bloomberg.

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