Save Your (Family) Dollars

The discount retailer has improved, but its stock isn't a bargain.
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Family Dollar's (FDO) second-quarter earnings report Thursday showed that the discount retailer has made some strong strategic moves.

For the quarter ended March 3, the company posted earnings of 60 cents a share on revenue of $1.95 billion, matching analysts' estimates. Earnings were 35 cents a share a year ago, when results included an 18-cent litigation charge.

Family Dollar also reaffirmed guidance for the current quarter and year, forecasting earnings of 39 cents to 43 cents a share for the third quarter and $1.63 to $1.69 for the year. Wall Street currently expects earnings of 41 cents a share for the quarter and $1.65 for the year.

I like what I'm seeing at Family Dollar. The company's margins are improving, and it has been smart in adding consumables and focusing on an urban strategy to enhance performance.

Nevertheless, I want to see the stock trading at the same bargains it offers its customers before getting involved.

Considering rival

Dollar General's

(DG) - Get Report

recent takeout announcement, some investors believe Family Dollar may be next up in the group for a buyout. It's certainly possible, but I believe potential suitors will want to see more evidence that the company's new initiatives are working.

That being said, the early results are positive. Family Dollar also boosted its sales per square foot to $79.70 in the first half of the fiscal year, compared with $77.06 in the comparable period last year.

Gross margin in the quarter rose to 33.5% from 32.9% a year earlier. The gain is impressive when you take into account that consumables, a relatively new product category, have lower margins than other types of goods.

Consumables formed the fastest-growing category in the quarter, with sales up 15.6% in the quarter. Although the consumables have lower gross margins, they add gross margin dollars, because Family Dollar's core customers -- shoppers in the lower-income category -- tend to spend more of their income on food and make frequent fill-in shopping trips as opposed to spending one large chunk of their paycheck at somewhere like

Costco

(COST) - Get Report

.

When asked on the company's conference call about the state of the lower-income consumer, Family Dollar CEO Howard Levine said that demographic "is always stressed and always strained." That said, the rise in the minimum wage should help that group of consumers and spill over to Family Dollar and its peers.

On the flip side, rising gas prices hurt lower-income customers disproportionately to the rest of the population. More dollars spent on filling up tanks likely means less treasure-hunting at Family Dollar. And this treasure hunt is critical to Family Dollar if it wants to improve margins, since products such as apparel and home goods typically carry a higher gross margin than other items.

Fairly Priced

Compared with its peers, Family Dollar is less expensive on a price-to-earnings and forward P/E basis. However, when you take expected growth into account, the stock is trading right in line with the group.

Among Dollar General,

Big Lots

(BIG) - Get Report

,

Tuesday Morning

(TUES) - Get Report

,

Dollar Tree

(DLTR) - Get Report

and

Fred's

(FRED)

, Family Dollar has the slowest projected long-term growth rate. It stands at 11.5%, compared with 13.2% for the group.

Family Dollar's stock currently trades around $29, and I'd like to see it fall to the $24 to $25 range before I'd be interested. It would put the stock at a discount to its peers on a P/E-to-growth metric and would give investors a better buffer against the strategy risk.

Keep in mind, I do believe Family Dollar's approach to growth is the right one, and it appears to be working. But serving a customer base that has to think about nearly every dollar it spends carries significant risk on both a macro and company level.

From a technical perspective, $23 to $24 is an area of support that would also provide some peace of mind that the downside is somewhat limited.

Family Dollar is moving in the right direction. But as is true in many situations, I like the company but not the stock right now. Give it to me cheaper, and I'm willing to take a shot.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

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