Walmart Shows Signs of Decreasing Direct Import Business with Aisa. Will FDO follow trend?

I know this is not the latest news, but it is still relevant. Here is an interesting article from earlier this year about Wal-Mart signing a sourcing contract with giant trade agency Li & Fung. This is a little backwards of previous trend of going direct.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aSDzLcEyoNas

So if Wal-Mart has backup its integration efforts will other retailers take note and follow suit? I imagine so. I think that Wal-mart has learned that they just cannot control every facet of business. You can have experts in every area of product. Thus you have new strategic alliances forming to maintain supply chain activities.

Family Dollar should take notice. Having such a strategic partnership with several agencies could give them several benefits.

1. They save their employees time on project and increase efficiency
2. They reduce the risks by having an intermediary
3. They have a stronger voice within various industries
4. They can bring better quality and styled goods to market
5. They increase external resources for product sourcing and development

Typically, larger retail companies have pushed for integration closer to the source of goods to save costs, but how close is too close. I think companies are finally realizing diminishing returns on direct sourcing because some outside firms really do add value to the import process.

An interesting article on Should Family Dollar and Dollar General Merge.

Credit Suisse

A PERFORMANCE AND VALUATION GAP between Family Dollar (Ticker: FDO) and Dollar General (DG) has emerged.

Current consensus earnings-per-share estimates imply a 19% cash-flow return on investment (CFROI) for Dollar General in 2009 (900 basis points above its 10-year average), versus a 9% CFROI for Family Dollar (in line with its 10-year average). In part due to this differential, Dollar General currently trades at a 20% premium price to earnings multiple to Family Dollar based on our 2009 calendar estimates.

We believe Family Dollar is well positioned to capitalize on several operating initiatives to narrow its performance gap with Dollar General. By the end of its current quarter, Family Dollar is set to complete its initiative to roll out food stamp and credit-card acceptance on a chain-wide basis and move its store-hour extension initiative from a test of 15% of stores to chain wide implementation. In addition, it will continue remodeling stores to allocate more space to consumables and improve adjacencies and sightlines.

Here's the rationale for a Dollar General/Family Dollar merger. If a performance gap between the two entities persists, we believe a merger of the two companies would make sense. Dollar General could implement its proven initiatives in Family Dollar stores such as shelf-height increases and category management changes, helping to boost Family Dollar's sales productivity to a level closer to its own.

We see no structural impediment to Family Dollar stores reaching Dollar General sales-productivity levels if the two dollar stores were to merge, given their virtually identical store size, merchandise offering, pricing strategies, target customers, and only 50% store overlap (defined as stores within five miles of each other). Closing underperforming stores that do closely overlap would allow a transfer of sales from closed stores to nearby locations.

We estimate a combined Dollar General and Family Dollar could generate EPS power of approximately $2.20 by 2012 (versus our current 2010 EPS estimate of $1.60 and 2011 EPS estimate of $1.80 for Dollar General) based on the following assumptions: Dollar General pays a 35% premium for Family Dollar; acquisition funded entirely through newly issued Dollar General shares; Dollar General closes 20% of overlapping Family Dollar stores and reduces 20% of store level selling, general and administrative expenses, improves existing Family Dollar sales productivity by 8%-9% in both 2011 and 2012, and reduces Family Dollar duplicate overhead (non-store level) expenses by 30% in 2010 and 15% in 2011.

-- Michael Exstein
-- Tom Roller
-- Christopher Su

Strategic Fits in Supply Chain Activities

Family dollar enjoys some economic advantages from the size of their business when it comes to suppliers. These economies of scales allow them to pick and choose who they want to get products from based on benefit packages. They can go direct to manufacturer to get private labels because of the volume of products they have. They can bypass domestic distribution supply chains and move straight to the source when the intermediaries add no tangible benefits. Why should they buy paper products for a brand name when they can use a private label and save 30% off cost and give the customer a lower price and free up income to maximize the customer’s utility. They can partner with the same guys that make brand name chemicals, food, or paper products and have private labels. At such a value level of retail the customers are there to save money. If the products are close substitutes and maximizing income is the goal of consumers these strategic relationships literally makes cents.

Family Dollar Announces $250 Million Accelerated Share Repurchase

MATTHEWS, N.C., Oct 06, 2010 (BUSINESS WIRE) –

Family Dollar Stores, Inc. (NYSE: FDO) announced today it entered into an accelerated share repurchase agreement with Wells Fargo Bank, N.A. under which the Company will repurchase shares of its common stock. The Company is repurchasing shares under the agreement as part of its previously announced $750 million share repurchase authorization.
Under the accelerated share repurchase agreement, the Company will pay an aggregate of $250 million to the bank on October 7, 2010, for a number of shares that will be determined based on average prices of the Company's common stock during a specified period. The Company is funding the repurchase with cash on hand.
As the repurchase of common stock is expected to be accretive to earnings per share, the Company is updating its earnings guidance. Earnings per diluted share, including the impact of this $250 million share buyback, are now expected to be in the range of $3.04 to $3.24 per diluted share for fiscal 2011.
The Company's outlook for fiscal 2011 is based on the following assumptions, which may or may not prove valid and does not reflect any additional stock repurchases or any incremental borrowings:
• An increase in net sales of between 8% and 10%;
• An increase in comparable store sales of between 5% and 7%;
• Approximately 300 new store openings and 80-100 store closings;
• An increase in the operating margin based on flat gross margin and lower SG&A expenses, all as a percentage of sales;
• An effective income tax rate of approximately 36.5%;
• Weighted average diluted shares of approximately 127 million; and
• Capital expenditures of between $300 million and $350 million.
For the first quarter of fiscal 2011, the Company expects that comparable store sales will increase between 5% and 7% and that earnings per diluted share will be between $0.56 and $0.61 per share.

Focused Low Cost Strategy

Family Dollar should be classified as having a Focused Low Cost Strategy because they have a focused product line contained in 7,000 square feet of retail space. They limited selection, but what they do offer is value driven by price. There store locations and merchandise reach out to its target customers demographics which are areas that have a high concentration of household annual income less that $30,000 which is below the 2008 US Census $52,000 per capita income. Their niche is serving lower income Americans and providing them with quality goods at low prices in a convenient location.

This is well stated in their mission and vision statement:

For Our Customers
A compelling place to shop. . .
by providing convenience and low prices

Our Vision:
To be the best small-format convenience and value retailer serving the needs of families in our neighborhoods

Vertical Integration and Outsourcing

Family Dollar shows more signs of backwards vertical integration by moving up the supply chain to do more direct imports. There was a time when all goods were bought through domestic wholesale companies who stocked goods and domestic manufacturers. As the global economy changes to oversea production there are more trading companies, buying agents and subcontractors that are helping to cut margin out of the supply chain to give there customers better value. Right now with the economic recession consumers are more likely to adopt private brands and off label brands to save money. These types of changes in consumer taste are likely to fuel Family Dollar to get closer to the source by outsourcing merchandising functions to 3rd parties. These 3rd parties don’t have the overhead of stocking distributors and can operate on lower margins and they add value to Family Dollar by not having to hire more people to do this job to realize savings. It also shifts product liability from Family Dollar to the 3rd parties.

Having there own warehouses and distribution centers is another way Family Dollar can show vertical integration to save money by not outsourcing these services. They have 9 DC’s in the following locations: Matthews, NC; West Memphis, AR; Front Royal, VA; Morehead, KY; Maquoketa, IA; Odessa, TX; Marianna, FL; and Rome, NY. I am sure these locations were picked from the geo-demographics that combine central locations in small communities with low overhead costs o serve their 6,800 locations.

Mirco-SWOT Analysis

Strengths

Family Dollar has continually increase sales and mange debt.

They have huge market share and visibility.

There sales have increased during the recession.

FDO is starting to become more profitable on per share basis


Weakness

The company performs better in a weaker economic environment.

The company has product shelves filled with substitute goods.

Opportunity

Grow more by adding more stores into new territories.

Slow economic recovery is foreseen.


Threats

Competition – Dollar General is aggressive and larger. They just expanded product line to carry beer.

The substitute good effect diminishes when income rises or economic uncertainty decreases then consumers will return to preferred brands.