With the Family Dollar Merger Complete, Now the Hard Part Begins for Dollar Tree

During the period in which Dollar Tree (NASDAQ: DLTR) and Dollar General (NYSE: DG) fought tooth and nail to be the acquirer of Family Dollar (NYSE: FDO), all I could think was, “Why are they fighting over a garbage operation?”
For years, I had been writing articles comparing all the dollar stores, and it always ended the same way: Dollar Tree had the best metrics and operational results, and Family Dollar had the worst.
Now that the Dollar Tree-Family Dollar merger has closed, what’s ahead for the combined entity?
And, should you buy the stock? I think the answer is “no.”

Metrics of a Stinker

First, look at the differences in metrics and see if you scratch your head as I did.
Dollar Tree has a bit under twice the market cap of Family Dollar and half the employees. Even though it has 20% less revenue, it has 7% better gross margins and 8% better opearting margins. Despite having 20% less revenue, its trailing 12-month net income was $530 million vs. Family Dollar’s $246 million.
Why is Dollar Tree buying this stinker?
A few years back, Dollar Tree was growing at a 15% clip. That organic growth has slowed considerably. I guess management sees its limping rival and thinks it can shape it up in short order. I suspect this integration will prove to be difficult. However, Dollar Tree management has traditionally shown great acumen and it’s fair to say that if anyone can turn Family Dollar into a member of the Dollar Tree family, this management team can.
The combined entity will match Dollar General’s scope, as each will have about 13,000 stores in the U.S. Both will have a combined $4.8 billion to $4.9 billion in quarterly sales.
Let’s put the entities together and see what numbers we come up with in our quantitative analysis.
Dollar Tree has $540 million in free cash flow over the trailing 12 months. It had $8.78 billion in sales. Operating income was $1.04 billion. Net income was $530 million.

Family Dollar Is a Drag

Family Dollar has NEGATIVE $470 million in free cash flow over the trailing 12 months. It had $10.54 billion in sales. Operating income was $370 million. Net income was $246 million.
As you can see, Family Dollar is a real drag. The combined entity thus will have $19.2 billion in sales, operating income of $1.41 billion, and net income of $776 million. Clearly there will be a free cash flow problem thanks to Family Dollar’s inefficient supply chain and other quality control issues. The combined entities trade at 25.6 times net income, which on earnings per share growth of around 12%, is way too expensive.
So if you hold either stock, it’s time to take your profits. Look at it this way: It’s going to require a lot of heavy lifting to do this integration and I think the stock is moribund for quite some time. It may even fall if the market gets bearish on the integration. Regardless, I think you’ll be able to get it at a cheaper relative value.
Dollar General will have $19.4 billion in sales, $1.83 billion in operating profit, net income of $1.1 billion, and free cash flow of $1.36 billion. Thus, Dollar General is trading at 22 times net income, with EPS increasing at about 14% annually. That’s somewhat pricey for a quasi-growth stock, so I wouldn’t go hunting for Dollar General at that price.

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