Stock Spotlight: Family Dollar (FDO)

TK All-Star posted on 10/14/09 at 03:16 PM

Alan Brochstein suggests earning your family some dollars – in more ways than one.

A few weeks ago, I was examining stocks in the S&P 500 that were having a lousy Q3.  I ended up sharing my work on Seeking Alpha, where I discussed 15 stocks that met my stock screening requirements. Here are the criteria I used to filter the universe of S&P 500 stocks that were down in Q3:

•    50-day Moving Average (50dma) > 20-day Moving Average (200dma) (maximum 10%)
•    P/E (Price / Earnings Ratio) for the last fiscal 12 months
•    Net Debt-to-Capital Ratio < 60%

The first constraint helps assure that the stock’s trend is up, but it isn't overextended. The second constraint makes sure the P/E isn't super-inflated. The final factor should help kick out balance-sheet disasters.

I had recently added one of the stocks that met the criteria, Family Dollar (FDO), to my Conservative Growth/Balanced Model Portfolio. Since then, I added to that position (average cost of 26.61) and also added it to my Top 20 Model Portfolio (average cost 26.52). While the stock popped Tuesday 10/6 on an upgrade, it’s well below my 1-year out target of 35 (14X the August 2011 consensus earnings estimate of 2.53). I believe the downside is quite limited, most likely to 24. 

Before sharing more specifics on FDO, take a look at its 10yr history. You can see the forward P/E displayed in the bottom panel:


 
See a larger version of this chart.

Family Dollar (FDO) is one of several publicly-traded “dollar stores”, general merchandise retailers focused predominantly on the lower-income demographic. I have followed this one for almost 10 years now. You may also be familiar with either Dollar Tree (DLTR) or 99-Cents Only Stores (NDN), and you may recall the formerly publicly-traded Dollar General (supposedly going public again). 

I see several great points about FDO, but let me get three negatives out of the way. 

•    First, they are purely domestically based.

•    Second, they are more mature than they used to be (6500 stores now). While neither of these facts makes this a bad company, I do think that they help explain why the stock has gotten so cheap.

•    The final challenge for the stock is that its margins are perceived to lack leverage in an improving economy. It’s a possible risk to FDO that newer customers may “trade up” and stop shopping FDO when the economy improves. I, for one, am not expecting a robust economy any time soon; even if we did get that luck, it seems as though “value” will remain in style for quite some time.

So much for FDO’s less attractive points. Here’s what I do like about the stock’s prospects:

•    Strong balance sheet and cashflow. The balance sheet shows net cash of about $80mm, with inventory growth below sales growth. Through the first 3 quarters, free cash flow was up 32%. The company has a dividend yielding just below 2% and representing a low 26% payout, and they have increased it every year since 1982. In my view, the balance sheet and cashflow metrics look quite solid.  

•    Very cheap by a number of metrics. As noted above, P/E valuation is near its lows over the past decade and well below the average. Other valuation metrics confirm this, including P/S (Price / Sales) and P/B (Price / Book). FDO also has a lower PE than the majority of its peers, including DLTR and NDN as well as Wal-Mart (WMT), Fred’s, Inc. (FRED) and Ross Stores (ROST).  

•    Good Management Alignment. FDO’s CEO owns 6% of the company, an encouraging sign.   

•    Two potentially big growth drivers. First, FDO is in the early stages of allowing customers to use food stamps or credit cards. An additional driver has been FDO’s increase towards consumable staples like milk. 

In short, I see FDO as a relatively cheap, well-positioned player, with adequate capitalized skin-in-the-game and a couple of smart growth drivers working for them.

That said, FDO is a defensive investment in many ways. Not only is the business somewhat counter-cyclical due to its focus on low prices, but the balance sheet and low valuation make this stock quite defensive. I think the proof is in the price action over the past 20 months or so, with the stock rallying from its early 2008 lows and peaking in March of this year. That looks like a negative beta!

In any event, I think this is a time when the best offense is a good defense, which makes FDO a buy vs. the market in my book. Let’s see how it plays in the live market!

Regards,
Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

Disclosure:  Alan is long Family Dollar (FDO) in both of his model portfolios, Top 20 and Conservative/Growth Balanced, as well as a charitable foundation he manages privately on behalf of his parents.

In reading content in the Trader Network, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.

Alan Brochstein maintains a cross-marketing relationship with TradeKing.
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Posted by TK All-Star on 10/14/09 at 03:16 PM

Comments

NOVAL posted October 17, 2009 (11:45PM)

I have been trading for several years, have studied & done mucho reading on how to read charts & technical analysis, but I just cannot seem to get it when reading charts. I find that when reading a chart hindsight works great, but as I look at the ups/downs/sideways etc., I do not have a clue from the chart as to which way the stock is likely to move from current day forward.  I look at Bollinger Bands, SMA's, EMA's, etc. The only thing that looks readable is volume, but then when there is a big volume spike it seems to be too late to take advantage of the move.  Would appreciate your commentary chart reading.  Thanks. noval

TK All-Star posted October 20, 2009 (10:07AM)

Good questions, Noval. Technical analysis is a useful tool, one that I have used for about 30 years and continue to study for new ideas. While many people believe that it can be used alone or with perfect outcomes, I try to remember that it is just part of an arsenal of tools that investors can use to help make wiser investment decisions. While I use it to help me with my short-term timing, I find that it can be very useful in terms of longer time-horizons as well. Technical analysis helps me determine the long-term trend or a potential reversal of that trend.

I agree with you that volume is very important, but I use it perhaps differently than other traders or investors: I focus on volume at a price. Using a histogram, I can see key areas of support and resistance based upon prior trading volume. When I look at Family Dollar, I classify the long-term trend as up (from January 2008) but consolidating. Looking at the volume at a price, the 27 area has been the highest volume over the year, and the distribution looks rather normal. Beneath that level is the 25.50 area, which I view as support if 27 were to fail. 30 is a high volume spot as well, and it coincides with the 150dma (which I use rather than the 200dma as my "long-term" trend).

Another tool I like that you didn\'t mention is known as the Fibonacci Retracement, which helps define normal corrections. Based on the low of 15.50 (Jan 2008) and the peak of 35 in April, the stock had a 19 1/2 point move. One would expect that the long-term trend is intact as long as the correction doesn\'t retrace more than 61.8% (or 12 points). A good correction would be 38.2% (7.5 points). The stock corrected 9.5 points, so the long-term trend is still up with the low potentially in.

I hope that helps! If you're looking to learn more about technical analysis, TradeKing offers plenty of good resources to advance your knowledge:

Steve Nison's All-Star posts about candlesticks charting patterns:
http://community.tradeking.com/members/tk-all-star/blogs/18129-steve-nison-on-candles-engulfing-patterns

Chris Wilson's All-Star posts about Elliott Wave, a school of technical analysis:
http://community.tradeking.com/members/tk-all-star/blogs/20459-which-elliott-wave-are-we-in-now

Check out Steve and Chris' many webinars expanding on these topics in TradeKing's Learning Center: https://www.tradeking.com/education/videos

The Technical Analysis Suite under Quotes + Research includes a great educational module that should be a big help, too.

Regards,
Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

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