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Must-know: Carl Icahn cuts down stake in Family Dollar stores

Part 4
Must-know: Carl Icahn cuts down stake in Family Dollar stores (Part 4 of 5)

Why Family Dollar has underperformed its peers

Family Dollar has underperformed its peers

Activist investor Carl Icahn’s hedge fund Icahn Capital trimmed its stake in Family Dollar (FDO) stores last week after the deep-discount retailer agreed to a takeover deal from rival Dollar Tree Inc. (DLTR) for $8.5 billion. Icahn, who disclosed an activist position in June, had urged the company’s board and management to pursue “operating initiatives or explore strategic alternatives.”

FDO operating marginsEnlarge Graph

Icahn sent a letter back in June to Family Dollar CEO Howard Levine threatening a proxy war if the company wasn’t “put up for sale immediately.” He added that, “Family Dollar has consistently underperformed its peers on most, if not all, operating metrics—same store sales, total revenue growth, sales per store, sales per square foot, operating margins, and capital structure efficiency—and faces growing competition. In addition, the company’s shares have underperformed not only the shares of its peers, but also the S&P 500 index over the last one-year and three-year periods.” Icahn noted that the time for a sale was right “given the advantageous stock market and interest rate environment” and that “strategic and financial buyers could recognize massive synergies from an acquisition of the company.”

Family Dollar was founded by Leon Levine in 1959 with the opening of the first Family Dollar store in Charlotte, North Carolina. It currently operates a chain of more than 8,200 general merchandise retail discount stores in 46 states. It targets low- to lower-household income consumers and provides them with a selection of competitively priced merchandise in convenient neighborhood stores. Its merchandise assortment includes Consumables, Home Products, Apparel and Accessories, and Seasonal and Electronics.

Family Dollar shifts strategy to “everyday low prices”

The company said its quarterly results have been impacted by the macro-economic and highly competitive and promotional retail environment. With increased financial pressures and challenges including high unemployment rates, volatility in food, gasoline, and energy costs, and uncertainty in healthcare programs, Family Dollar believes its customers continue to focus spending on items they need and less on discretionary purchases. Family Dollar’s management noted on its 1Q14 earnings call in January that although the introduction of tobacco and store renovations last year attracted customers, they also resulted in significant margin pressure, higher store manager turnover, and lower inventory productivity. They added, “We strayed from our core strategy of serving the value-conscious consumer.”

Analysts believe the company underperformed its peers Dollar General (DG) and Dollar Tree (DLTR) due to its strategy of high price strategy. The company added on its 1Q14 earnings call that it plans to abandon expensive promotions and shift back to its “everyday low prices” strategy. The move involved investing more than $50 million on an annualized basis to lower prices on nearly 1,000 stock-keeping units (SKUs) that will enable FDO to be more competitive, the management said on its recent earnings call.

Restructuring efforts included 370 store closures

Following two quarters of weaker-than-expected results, Family Dollar initiated an in-depth business review in April to “identify opportunities to strengthen its value proposition, increase operational efficiencies and improve financial performance.” It announced immediate strategic actions to improve performance that include a significant investment to lower prices on ~1,000 basic items, cost cuts, and the shutdown of ~370 under-performing stores. These actions were expected to result in $40 million–$45 million of annualized operating profit benefit, beginning 3Q14. The dollar store chain said it intends to slow new store growth beginning fiscal 2015 to improve return on investment.

Discount retailers such as Family Dollar, which expanded during the Great Recession, have seen slowing same store sales as low income customers have been pressured by slower wage growth, higher payroll taxes, and federal cuts to food stamp and unemployment benefits. Family Dollar and its peers Dollar General and Dollar Tree are also facing competition from big-box retailers, such as Walmart (WMT) and Target (TGT), who are expanding with small-format stores as shoppers increasingly look for convenience.

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