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Family Dollar Stores - The Need for Clean Pants

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April 02, 2010 – Comments (0) | RELATED TICKERS: FDO , NDN , DLTR

We read an article last week on the CNN Money site last week that reinforced why we think the markets are creating another stock bubble.

Then yesterday we noticed an article at the New York Times site that talked about the excessive risks that have been taken, and are still being taken, by Wall Street. "The fact is that Wall Street has always been - and remains - very much a Boys Club.", the article said.

Which brings us to Family Dollar Stores, Inc. (NYSE: FDO). The stock price has increased 25% since the beginning of the year, and was up 11% in March alone.

At first we were confused about the reason for the run up in the stock price. Certainly economic conditions are playing a role, but then we found that Credit Suisse, Goldman Sachs, and Merrill Lynch, all have the stock listed as either Buy or Market Outperform, making us wonder just who is going to benefit when the stock price finally rolls over.

Basis
Financial information related to Family Dollar Stores, Inc., contained in this report, is based on the company's most recent SEC Form 10-K filing for fiscal year ending August 29, 2009, as filed with the Securities and Exchange Commission on October 27, 2009.

What They Do
Family Dollar Stores operates a chain of more than 6,600 general merchandise retail discount stores in 44 states, providing primarily low to middle income consumers with a selection of competitively-priced merchandise in convenient neighborhood stores.

The company's merchandise includes consumables, home products, apparel and accessories, and seasonal and electronics, sold at prices that generally range from less than $1 to $10.

The first Family Dollar store was opened in Charlotte, North Carolina, in 1959, and in subsequent years, additional stores were opened with separate corporations established to operate these stores.

The company was incorporated in Delaware in 1969, with all of the then existing corporate entities, becoming wholly-owned subsidiaries of Family Dollar Stores, Inc.

Short-Term Investment
Let's see if we can put this in perspective for the average short-term investor that does not have 897 supercomputers executing trades. The stock closed recently at $37.00 which is almost 2% above its 13 day moving average, and almost 9% above its 50 day moving average.

The stock also have resistance at $37.20, its 52 week high and a 1% increase from a recent close, and finds first support at its 50 day moving average of $33.51, a 9% decline from a recent close.

Should the stock price break through first support, the next support it will find is the 200 day moving average of $30.24, an 18% decline from a recent close.

Long-Term (5 Year Hold) Investment
We are going to say this as simply as we can. Sell this stock. The company spends more on dividends and stock repurchases than on debt reduction, almost 2.5:1 more. The company has a current ratio of 1.5, an acid test ratio of 0.43, and a cash ratio of 0.42, none of which are investment quality in our opinion.

We would have been amazed had it been any other way, but the company's receivables are outstanding on average, less than one day, while it's payables are outstanding an average of 41 days. While we are all in favor of free money, we wonder how this screw might turn in the coming months, should the economy continue to deteriorate?

The company does have very good free cash flow at $2.75 per share, and a very healthy return on invested capital at 33%, both very positive signs. Which makes us wonder just why management isn't spending some of the company's cash to reduce debt, instead of paying dividends and buying back company stock.

Final Thoughts
We think a risk adjusted entry target for the stock is $22-$25, a price range that our very preliminary research seems to support.

Coupling that with the ratings from the Boys Club elite and the tremendous increase in the stock price since the first of the year, we have to wonder if folks investing in this stock at current levels, won't once again be left with skid marks on their underwear.

Wax

To download the Wax Ink Family Dollar Stores Raw Value Worksheet, please click here.

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