A Cheap Alternative to the Dollar Stores

By Eric Novinson - June 12, 2012 | Tickers: DG, DLTR, FDO, FRED | 0 Comments

Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinions of our bloggers and are not formally edited.

Many well known discount stores are trading close to their yearly highs right now, as investors expect shoppers to pass up mid-market stores in favor of cheaper alternatives. Although this theory still seems reasonable, the rising valuations of the dollar stores have become a concern for some investors. An investor who wants to pay less of a premium for shares of a discount store might want to consider Fred's, Inc., (NASDAQ: FRED) instead.

The main value investing argument for Fred's, Inc, is that its book price per share is fairly close to its market price per share. Yahoo Finance gives a book value per share of $11.56 for Fred's, and a market share price of $14.23. Dollar Tree (NASDAQ: DLTR), Dollar General (NYSE: DG), and Family Dollar (NYSE: FDO) have book values per share of $12.76, $13.82, and $10.43, respectively. At share prices of $106.72 for Dollar Tree, $50.29 for Dollar General, and $69.58 for Family Dollar, Fred's shares look like a relative bargain.

Fred's does have a lower profit margin, at 1.8 percent, than the main dollar store chains, as Dollar General, Dollar Tree and Family Dollar have margins of 5.4 percent, 7.4 percent, and 4.6 percent respectively. This smaller profit margin helps explain why Fred's price to sales ratio is so low,at 0.28, although Fred's 2010 annual report did provide information about some steps Fred's has taken to boost its profit margins.

Fred's 2010 annual report announced that the company planned two strategies that could help raise its margins: introducing more well known national brands, and selling more of its own store brands. A visit to Fred's websitein June 2012 showed that the company offered several prominent national brands to its customers, including Charmin and Angel Soft toilet paper, Coca-Cola and Powerade, and Downy and Sun detergent. As for store brands, Fred's current flyer also displayed a charcoal grill, with its own store brand charcoal and lighter fluid next to the picture of the grill. Andy Ashby's article in the Memphis Business Journal describes a Fred's concept store in Southhaven that offers a wider selection of national and store brands.

Fred's has also established itself in a business where its dollar store competitors are still getting started, pharmacies. Although many big boxes and supermarkets have their own pharmacies, and many pharmacies also offer a wide selection of discount products, Fred's dollar store prices could give it an edge against its large store competitors, while Fred's pharmacy offerings distinguish the company from dollar stores and other small general retailers. Fred's 2010 annual report announced that it bought 13 pharmacies from other companies and set up 21 of its own pharmacies during fiscal 2010. Fred's actually collected more than a third of its revenue from pharmaceutical products in fiscal 2010, and the company's share of revenue from pharmaceuticals has been rising.

Fred's balance sheet might also impress value investors, as grocery stores and discounters often have lots of debt and little cash. Although Dollar Tree's $382 million cash reserve and $266 million in debt looks better than Fred's cash reserve of $7.82 million and debt of $7.21 million, both Dollar General and Family Dollar have more debt than cash. Fred's might use up some of this cash by adding more pharmacies to its stores, but this could be a good use for the money.

Value investors often look for companies that trade near or below their book value, and Fred's looks much better than the major dollar store chains using this metric. Although the dollar store chains do have a profit margin advantage over Fred's, Fred's has rolled out a strategy that could improve its profit margins, which its concept store and store flier demonstrate. Fred's has also been beating the earnings estimates recently, and Fools give it a 4 star CAPS rating, which are two more points in its favor.

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Original post:
A Cheap Alternative to the Dollar Stores