In May, billionaire John Paulson’s Paulson & Co. filed its 13F with the SEC, disclosing many of its long equity positions as of the end of March. We track filings from funds such as Paulson’s as part of our work developing investment strategies (for example, we have found that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year) and because we maintain this database we can also look for big changes in his portfolio over time. It turns out that during the first quarter of 2013, Paulson initiated a position of 5 million shares in Family Dollar Stores, Inc. (NYSE:FDO), making the dollar store his largest new holding for the year. See the rest of Paulson’s stock picks. While we don’t recommend blindly following hedge funds (and Paulson has actually not been doing too well recently) we think that their picks can serve as sources of initial investment ideas.
The second quarter of Family Dollar Stores, Inc. (NYSE:FDO)’s fiscal year ended in early March. Revenue grew by 18% versus a year earlier, though there was an extra week in the quarter so in per-week terms the growth rate would be about half as high. In addition, the company’s margins fell and so the quarterly report actually showed total operating income being about flat (as was the case for fiscal Q1 as well). This suggests that while the market for dollar stores is not being saturated yet- as shown by the continually strong performance on the top line- Family Dollar Stores, Inc. (NYSE:FDO) is having trouble keeping its costs in line. In the first half of its fiscal year, cash flow from operations was down by nearly 40%, and again that is with an extra week.
Dollar General Corp. (NYSE:DG) and Dollar Tree (NASDAQ:DLTR) are two other well-known dollar stores. These peers feature very small premiums to Family Dollar on a trailing earnings basis, with P/E multiples of 19 and 18 respectively- so markets are expecting the entire segment to do well going forward. Dollar General Corp. (NYSE:DG)’s recent financial results look somewhat concerning, then, with revenue flat compared to a year ago. Margins have been increasing a bit, but we doubt that’s a source of sustainable earnings growth. Dollar Tree looks to be doing a bit better- in its most recent quarter net income was up 15% compared to the same period in the previous fiscal year, and if we were going to do more research on a dollar store that would likely be it.
We can also compare Family Dollar to Wal-Mart and Target Corporation (NYSE:TGT). These larger retailers are seen as having weaker growth prospects, and so their trailing P/Es are in the 15-16 range. Indeed, Wal-Mart’s recent quarterly report (for the first quarter of its fiscal year, the quarter ending in April) showed growth of only 1% from a year ago in both revenue and earnings. We’d note that even during the quarter reports surfaced that the retailer was off to a bad start of its fiscal year. Target Corporation (NYSE:TGT), meanwhile, experienced declining financials even after we adjust for special items. Specifically, operating income looks to have slipped by 20% though some of that came from the cessation of the internal credit card business. Given that these stocks are also priced for earnings growth, these numbers would be a cause for concern.
As a result, we would avoid many of these discount retailers with the possible exception of Dollar Tree. Even in that case, we’d have to examine why the company might be doing better than its peers (a trend we’re skeptical would continue). Family Dollar seems to be experiencing lower operating income on a per-week basis and so we don’t think that investor should imitate Paulson’s move here.
Disclosure: I own no shares of any stocks mentioned in this article.
