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Walmart Is in BIG Trouble as Family Dollar and Dollar Tree Merge

NEW YORK (TheStreet) -- The first major failure of the Doug McMillion administration at Walmart (WMT - Get Report) is clear: not being bold enough to pay a premium to buy the instant marketplace recognition and square footage held by dollar store Family Dollar (FDO).

As Walmart stays true to its insular culture, dollar store Dollar Tree (DLTR - Get Report) has realized the opportunity embodies its longtime rival Family Dollar. In a deal announced Monday, Dollar Tree will purchase Family Dollar for $74.50 per share, a whopping 22.8% premium to the closing price on July 25, 2014. Upon the deal's expected closure in early 2015, the company will operate a 13,000 stores across 48 states, a formidable retail presence, selling consumers fixed price merchandise ($1 or less) under the Dollar Tree banner and multi-priced goods at Family Dollar.

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Walmart shares were slipping 0.5% on the announcement to $75.60, a dip that has only begun to appreciate the lost opportunity to get closer to economically-sensitive customers in rural and urban markets that view a trip to a super-center as expensive. The addition of Family Dollar to Walmart would have afforded the retail giant the luxury of utilizing the smaller size of Family Dollar stores as same-day delivery hubs for merchandise.

Now, the world's largest retailer, which my Belus Capital Advisors rates as a sell with a $71.00 price target due to an outlook for continued margin pressure (this only worsens in a combined Family Dollar/Dollar Tree world), should expect an all-out assault on the fundamentals of its business. The merged dollar store is likely to benefit from deal synergies estimated at a $300 million run rate by the end of 2018 to invest in new store layouts that could offer more fresh food options, among other new offerings.

The looming competitive challenges for Walmart, on top of a U.S. business that is already struggling to such an extent that it recently led to the ouster of division president and chief executive officer Bill Simon just two weeks before the second quarter earnings release, could be seen in the store count comparisons.

Walmart U.S. (excluding Sam's Club locations)

  • California: 249
  • Florida: 272
  • New York: 101
  • North Carolina: 164
  • Texas: 420

Combined Family Dollar/Dollar Tree (estimated using most recent government filings)

  • California: 492
  • Florida: 912
  • New York: 540
  • North Carolina: 590
  • Texas: 1,299

Ultimately for Walmart, the dollar store merger comes at a time when it's allocating more capital expenditure to expanding its Neighborhood Market and Express formats, referenced by the company as "smaller store formats." For instance, a typical Neighborhood Market is one-third the size of a Walmart supercenter. The likely profit margin pressure caused by  a combined Family Dollar/Dollar Tree could constrain the long-term return on investment potential of these smaller Walmart stores, which are viewed by the company as critical in getting closer to its customers and facilitating quicker online service experiences.

On February 20, Walmart announced that it would add 270 to 300 small stores in 2014, doubling its initial forecast of 120-150. To support this growth, Walmart raised its U.S. capital expenditure plans for its current fiscal year to a range of $6.4 billion to $6.9 billion, from $5.8 billion to $6.3 billion previously.

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-- By Brian Sozzi CEO of Belus Capital Advisors, analyst to TheStreet. This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff. At the time of this publication, Belus Capital Advisors rated Walmart a sell. Brian Sozzi is the CEO and Chief Equities Strategist of Belus Capital Advisors. He is responsible for developing and managing an equities portfolio of mid- and large-cap positions, in addition to leading the firm's digital content initiatives. He is also a personal finance columnist for Men's Health magazine.

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