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3 O'Clock High: Retail Reporting


Did I say slobber-knocking? Good, just making sure.


As has been stated in my bio ever since I got here, I serve on the board of Duckwall-Alco (DUCK), a very-small cap discount retailer based in Abiline, Kansas (Ike's hometown!). I've been there for almost seven years and it's been a tremendous, if occasionally maddening, experience. I've become a better investor and business person as a direct result of the work and it's provided me with a rich vein of experiences from which I draw often.

Of course, we can't discuss any of those events here. In fact, even mentioning one of my other day-jobs inclines me to make clear that I am in no way recomending any investing action in Duckwall-Alco. Again, the stock has a very small market cap and is thinly traded. Nothing in this or any other column I have written or will write is to be construed in any way as advice regarding Duckwall nor is such information in any way material and/or not already publicly available.

As the above suggests, Job 1 for directors in 2005 is "Cover Your A** at all cost. What used to be leadership will get you killed and we're all one erroneous audit from Rahway. Complaining about misguided and overzealous legislation is tantamount to confessing guilt. Shut-up, lay-low and wait out your term. Do what the lawyers and auditors tell you to do and you may get out of this alive."

Which is another column.

A more traditional function in a board capacity is to keep an eye on the competition and industry trends. What's working with the ever-fickle consumer and which companies are taking advantage of it? You're not seeking to knock-off more successful chains but you can't pretend to operate in a vacuum either.

When a chain does over $5 billion in revenues in roughly my company's target market, it's best to pay some attention. Doing so is much the same process as researching an investment.

Family Dollar (FDO)

Discount retail is cutthroat, with even the best operators struggling to even approach a 10% net margin. Family Dollar (FDO), who reported this morning, operates over 5,000 discount stores targeted to "the low-end demographic" where the target margin is closer to 5%.

Family Dollar expanded by over 500 stores (greater than 10% in square footage) in each of the last two years. From under $5 per share in 1996(split adjusted) the stock rose to nearly $45 in 2003, before the company hit the law of large numbers and the stock hit the wall.

A one-time darling, FDO is now a serial earnings misser. Great things were not expected for the quarter ending August 28th.

The Report

Family Dollar reported earnings of 18-cents per share vs. expectations of 17-cents. Same store sales for the quarter rose .6%. Guidance for the coming year was set at $1.30 to 1.39 vs. 1.30 for '05 and Street expectations of 1.39.

The Reaction

The problem with setting the bar low is that you don't get a lot of credit for clearing it. Family Dollar has been down about 1% all day, not a woodshed-clubbing but notable on a generally retail-friendly day.

The Rationale

I can't really separate my roles of "investor" and "director" when I look at retailers in any segment, let alone discounters. I have no official reaction as a Duckwall director and, obviously, I'm not in any way employed by Family Dollar. I should be assumed to have no special insight to their thought processes.

What I can do is tell you why I think the Street continues to avoid Family Dollar like the plague (or Montgomery Wards or Ultimate Electronics etc. as an investment. It can be safely inferred (while I am not officially implying) that my criticisms of FDO as an investment would be much the same as the issues I would raise with management, were I a director there.

Which is about as close as we can get to the "real story" these days.

  • SG&A Ramping. Expenses as a percentage of sales ("SG&A" or "overhead") rose to 28.6% vs. 27% a year earlier. In deep discount retail, a 6% increase in the number is nearly beyond any reasonable explanation. Unless they are creating cold-fusion this is a huge red flag as an investment.
  • Margins Shrinking... seemingly by design. FDO expects gross margins to continue to shrink due, in part, to a shift from soft-lines (clothes, generally higher margin) to hard-lines (food). What's the company doing about it? Embracing the problem by installing coolers in 2,500 stores.
  • Logic Fuzz: Coolers. Expanding on that cooler thing, the company put coolers in 20% of their store base (give or take, 1,000 stores) in 2005. The explanation still in effect is that coolers, though expensive to buy and bulky in terms of floor space, would help "drive traffic" in the stores. Last year, the first of the Great Traffic Driving Cooler Initiative, saw the average number of transactions in comparable stores decrease .7%. At a time when it would seem advisable to reconsider the financial impact of the cooler roll-out, the chain is accelerating the move.
  • Stock Buybacks at any price. Family Dollar bought 3.3 million shares of FDO stock in 2005, paying $92 million. In other words, they paid an average of $27.88 for a stock which, at this moment, is trading for $19.60. Where I live, that's just a lousy buy. You say "They couldn't have known the stock would go down"? Sorry, no excuses in trading or retail.
  • Excuses. This may just be a pet peeve but I hate it when company's whine about that which they can't control. "2005 was a challenging year for our customer and our company" is the opening comment.

My year was fine, dude... let's talk about those coolers.

  • Slowing Growth. Since the Family Dollar store model or operation is clearly creaking, if not outright breaking down, it's not necessarily a bad thing that the chain announced a cut back in the number of '06 store openings to 400 (from 530 average in '04 and '05). Of course they are going to spend the extra capital on coolers and buy-backs, which is less encouraging.

With the slobber-knocking the stock has taken all year, Family Dollar isn't a particularly expensive stock. From strictly an investment perspective the stock seems reasonably fairly priced. This isn't a death-spiral situation (yet?), there just isn't any reason to expect a turnaround with the company seemingly committed to the present course.

From a competitive perspective... well, it would be both impolite and ill-advised for me to say anything at all.

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Position in and BOD seat at DUCK

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