Family Dollar Stores, Inc.
Equity Valuation and Analysis
*As of November 1, 2007*
A Fundamental Study by:
Cody Baker
Nolan Bosworth
Ryan Huff
Denyel Johnston
T.J. Randolph
cody.baker@ttu.edu
nolan.bosworth@ttu.edu
ryan.t.huff@ttu.edu
denyel.johnston@ttu.edu
thomas.j.randolph@ttu.edu
0
Table of Contents
Executive Summary
3
Business and Industry Analysis
9
Company Overview
Industry Overview
Five Forces Model
9
10
12
Rivalry Among Existing Firms
13
Threat of New Entrants
19
Threat of Substitute Products
21
Bargaining Power of Customers
21
Bargaining Power of Suppliers
24
Value Chain Analysis
25
Firm Competitive Advantage Analysis
29
Accounting Analysis
34
Key Accounting Policies
35
Potential Accounting Flexibility
38
Actual Accounting Strategy
42
Quality of Disclosure
45
Qualitative
45
Quantitative (Screening Ratios)
47
Revenue Diagnostics
47
Expense Diagnostics
48
Potential “Red Flags”
53
Undo Accounting Distortions
53
1
Financial Analysis
56
Liquidity Ratios
57
Profitability Ratios
69
Capital Structure Ratios
79
Financial Statement Analysis
87
Income Statement
88
Balance Sheet
91
Statement of Cash Flows
94
Estimate Cost of Capital
96
Cost of Equity
96
Cost of Debt
98
Weighted Average Cost of Capital
99
Analysis of Valuation
101
Method of Comparables
102
Intrinsic Valuations Methods
109
Discounted Dividends Model
110
Free Cash Flow Model
111
Residual Income Model
113
Long Run Return on Equity Residual Income Model
114
Abnormal Earnings Growth Model
116
Credit Analysis
118
Analyst Recommendation
120
Appendices
121
References
148
2
Executive Summary
Investment Recommendation: UNDERVALUED, BUY (11/1/2007)
FDO – NYSE (11/1/2007):
$23.24
52 Week Change:
$21.03 - $35.42
Revenue:
$6.83B
Market Capitalization:
$3.27B
Shares Outstanding:
140.47M
Percent Institutional Ownership:
107%
Book Value per Share:
$8.195
ROE:
13.66%
ROA:
8.10%
Cost of Capital Est.
Estimate:
3-month
1-year
2-year
5-year
7-year
R²
Beta
.1046
.1050
.1052
.1053
.1052
.75
.75
.75
.75
.75
Ke
10.12%
10.12%
10.11%
10.11%
10.10%
Published Beta: 1.01
Kd(BT):
10.11%
WACC(BT):
4.724% WACC(AT): 7.95%
moneycentral.msn.com
Altman Z-score
2002 2003 2004 2005 2006
9.20 10.46 7.24 6.10
5.77
Valuation Estimates
Actual Price (11/1/07): $23.24
Financial Based Valuations
Trailing P/E:
$60.65
Forward P/E:
$31.14
PEG:
$22.09
P/B:
$15.31
P/EBITDA:
$37.86
P/FCF:
$37.86
EV/EBITDA:
$31.85
Intrinsic Valuations
Discounted Dividends:
Free Cash Flows:
Residual Income:
LR ROE:
AEG:
$16.82
$70.23
$31.62
$11.62
$27.21
moneycentral.msn.com
3
Industry Analysis
Established in Charlotte, North Carolina, Family Dollar has competed in the
discount store industry since 1959. North Carolina has remained the
headquarters of the company since opening, and distribution centers are located
in many states including: Arkansas, Kentucky, Oklahoma, Virginia, Iowa, Florida,
and Texas. Currently there are over 6200 Family Dollar retail stores in 44
different states throughout the country, all of which are geared towards low to
lower middle class income consumers (Family Dollar 10k). Most of the stores are
leased property and are smaller in size for the purpose of quick, easy opening in
populated and rural areas.
Family Dollar’s three main competitors are: The Dollar Tree, The Dollar
General, and 99 Cent Only. Wal-mart and Target are also classified in the
discount store industry, but are not direct competitors to Family Dollar. Family
Dollar and its competitors compete on price, rather than quality. Each store
offers generic and name brand products at discount prices. All stores sell nothing
over 10 dollars and are geared towards lower to middle lower class families.
Each of the companies are constantly opening new stores is neighborhood
shopping centers in order to gain market share and be more convenient for
customers. Convenience is important in this industry because, customers will
most likely not pass one store up to go to another.
There are many things that drive the industry, which are known as the
rivalry among existing firms. The industry has little consumer loyalty because the
products are undifferentiated, so the threat of substitute products is extremely
high. There is little threat of new entrants, due to the relationships established
with suppliers and low cost distributions. The bargaining power of customers is
moderate and the bargaining of suppliers is very low. The prices are already
discounted and the products are undifferentiated, so there is no room left for
suppliers or customers to bargain for lower prices.
4
The key success factors for the industry include: low cost distribution,
economies of scale, and tight cost control. By buying in mass quantity and using
the relationships with suppliers to obtain product for low costs, enables the
industry to offer the lowest prices. There is little advertisement within the
industry except for news paper fillers and other low cost ads, to keep the
expenses down, in turn keeping prices and costs low. Low prices and market
share are key success factors in this industry.
Accounting Analysis
A firm’s accounting policies are very important to understand in order to
be able to make accurate assumptions in the valuation process. (GAAP) allows
companies to be flexible in the way that they report their numbers and disclose
certain information. This creates many different creative accounting strategies
that vary from company to company. By going through and analyzing the firm’s
financial statements, the level of disclosure and accuracy is revealed. Accounting
analysis will also reveal any potential “Red Flags” in the company’s disclosure.
Family Dollar’s key success factors, as identified in the Firm Competitive
Advantage Analysis, are economies of scale, reduced input costs, low-cost
distribution, and a tight cost control system. This emphasis on cost leadership
creates the following Key Accounting Policies for the discount store industry:
lease treatment, merchandise inventories, intangible assets (particularly
goodwill), and employee retirement programs. The emphasis on minimizing costs
can be seen throughout the financial statements. The increase of revenue can
also be observed, in large part from the increase in stores and market share.
With flexibility in the (GAAP) policies, there is plenty of room to cover less
attractive financial data. Family Dollar is very open about all financial data and
implements the use of notes and descriptions explaining the numbers reported in
the financial statements. For the most part, Family Dollar’s reporting is very
transparent and easy to follow and expresses a level of disclosure. Family Dollar
is overall conservative when it comes to their accounting strategies.
5
A potential “RED Flag” that was uncovered was the way Family Dollar’s
operating leases where disclosed. When companies use and record operating
leases, they are usually only occupying the location for three to five years. When
using an operating lease, financial statements only show it as an expense
depreciated on a straight-line basis. After the time allocated, the company can
choose to renew their lease with the lessor. So, the company could end up using
the building for all of its useful life after all. This should then be recorded as a
capital lease, but isn’t with Family Dollar, which is a red flag for the company.
Financial Analysis, Forecast Financials, & Cost of Capital Estimation
An important part in valuing a firm is looking at a company’s liquidity,
capital structure, and profitability. These calculations are found by computing a
series of ratios for each item listed above. The firm’s financial statements are
then forecasted out using these ratios to predict future performance of the firm
and then compared to the rest of the industry. After this, a regression model is
formed to calculate beta, weighted average cost of capital, and cost of equity.
Family Dollar has descent liquidiity compared to the rest of the industry.
The liquidity is found by calculating numerous ratios. This assesses the firm’s
ability to pay off short term debt obligations, which is also a very important part
in valuing a firm. Family Dollar outperforms its competitors or the industry
average in all ratios except the Current Ratio and the Inventory Turnover Ratio.
Family Dollar shows weakness in these two categories but, demonstrates its
strength in its Days Supply Turnover and its Working Capital Turnover.
Profitability is also calculated through a series of ratios. Family Dollar is
struggling in this area when compared to its competitors. FDO had consecutive
decreases across the board in all ratios except for Asset Turnover and Gross
Profit Margin. When compared to the rest of the industry and FDO’s competitors,
this is a poor performance. With this being said, even with the decreasing ratio
percentages, FDO still beat the industry average in every profitability ratio except
Operating Profit Margin. The Family Dollar, even though beating industry
6
average, is performing poorly, in context to profitability ratios, when compared
to its competitors. The Capital Structure Ratios are important to find out how
much of the firm is financed by debt and equity. Family Dollar is doing well in
regards to its capital structure. There is a healthy amount of financing going on
with debt and equity and the company can sustain more growth than the current
growth rate. When compared to its competitors, Family Dollar is performing well
in this area.
After forecasting FDO’s financial statements, it is fair to say that there is a
steady increase across the board, which would indicate that the company is
growing. The company shows growth in assets, net income, sales, and many
other areas.
Valuations
The valuations methods are possible only after all of the above ground
work has been completed. These valuation models ultimately tell investors
whether or not to invest in Family Dollar so getting these models unbiased and
correct is the main purpose of the entire valuation project. It is also the reason
why two different valuation classes are utilized: the comparables methods and
the intrinsic valuation methods.
The comparables methods are done as preliminary valuations because
they are not based on solid financial theory. Most require the computation of an
industry average and then use this average to attain an estimated share price for
the firm being valued. As you can see in FDO’s case these estimations vary
significantly from a low of $15.31/share to a high of $60.65/share. All but two of
these comparables valuations show FDO’s share price to be undervalued. The
PEG and P/B ratios are the only methods that show any overvaluation. Even
despite that most show FDO is undervalued, because of the wide range of share
price estimations and their lack of financial theory, the comparables methods
should never alone be used to value a company. They should be used as loose
guidelines that supplement the theory based valuation models.
7
The intrinsic valuation models are based on financial theory and thus, a
much stronger representation of the true share price. They are based on data
that was forecast from historical numbers for firm being valued. Of our intrinsic
valuation models three out of five show Family Dollar to undervalued. The
Discounted Dividends Model and Long Run ROE Model are the only two that
show FDO as overvalued. We considered the DD Model to be inaccurate
because it uses forecasted cash flows which are notoriously difficult predict.
Residual Income shows an undervalued share price and this model is much more
reliable because it is derived from earnings, dividends, and the book value of
equity. The Abnormal Earnings Growth Model also shows a fair to slightly
undervalued price and this model is based on the RI Model which uses more
accurately forecasted metrics. As stated before, the Free Cash Flow Model is
effectively useless do to the difficulty in forecasting cash flows.
8
Business and Industry Analysis
Company Overview
The Family Dollar is in the economic sector known as the discount store
industry. Established in November of 1959, in Charlotte, North Carolina, The
Family Dollar has evolved into one of the premier discount stores in the United
States. North Carolina has remained the headquarters of the company since
opening, and distribution centers are located in many states including: Arkansas,
Kentucky, Oklahoma, Virginia, Iowa, Florida, and Texas.
Currently there are over 6200 Family Dollar retail stores in 44 different
states throughout the country, all of which are geared towards low to lower
middle class income consumers (Family Dollar 10k). Most of the stores are
leased property and are smaller in size for the purpose of quick, easy opening in
populated and rural areas.
Each store carries a variety of both generic and nationally advertised,
name brand household and family goods. Most of the products in the store are
priced less than ten dollars in large part because of very low overhead and the
implementation of self-service. Higher product costs are also avoided by keeping
advertising costs at a minimum. Most of the Family Dollar advertising is
conducted through circulars inserted in the news paper or mailed directly to
potential customers. With the opening of 350 new stores and a 570 million
dollar increase in sales in the fiscal year 2006, Family Dollar is showing
consistency in sales increases in the past three years but, is opening fewer stores
going from 500 the past 2 years to 350 in 2006.
9
Family Dollar
2002
2003
2004
2005
2006
Net Sales (thousands)
$4,162,652
$4,750,171
$5,281,888
$5,824,808
$6,394,772
% Change
13.57%
14.11%
11.19%
10.28%
9.79%
Total Assets (thousands)
$1,754,619
$1,985,695
$2,224,361
$2,409,501
$2,523,029
% Change
25.35%
13.17%
12.02%
8.32%
4.71%
Stock Price
$28.55
$40.12
$26.45
$19.88
$25.57
% Change
6.45%
40.53%
-34.07%
-24.84%
28.62%
Industry Overview
The discount store industry is a very competitive market with many
legitimate companies. The largest stores in the discount category are Wal-mart
and Target. Wal-Mart dominates the industry, making 612.4 billion dollars in
sales in the fiscal year 2006, while Target made 51.6 billion dollars in sales. It is
clear that these two companies set the standard in the discount store industry,
but they are not considered direct competitors to the Family Dollar. Where WalMart and Target focus on providing customers with a larger variety of better
quality of goods, the Family Dollar and its direct competitors focus more on low
prices and the selling of mostly inferior goods. Three of the direct competitors of
the Family Dollar include: The Dollar Tree, The Dollar General, and 99 Cents
stores.
The Dollar Tree and The Dollar General are the company’s biggest
competitors. The Dollar General made 8.5 billion dollars in sales in 2006, making
it the biggest competitor to The Family Dollar. The Dollar Tree brought in 3.9
billion dollars in sales, and the Family Dollar made 6.3 billion dollars in sales in
the fiscal year 2006. The 99 Cents Store, a much smaller company, only made
about 1 billion dollars in sales in 2006. All the companies experienced an
increase in sales and an increase in the number of stores being opened. The
Dollar Tree opened 305 new stores, The Dollar General opened 300 new stores,
10
the 99 Cents Only Store opened 251 new stores, and the Family Dollar opened
350 new stores in the fiscal year 2006. The main competitive factors driving the
competition for customers in this industry are: price, location, customer service,
in- stock consistency, and presentation (Family Dollar 10k). With each company
opening new stores and sales sky rocketing, the industry appears to be growing
rapidly.
Comparison
2002-2003
2003-2004
2004-2005
2005-2006
Company Average
% Sales Growth
14.11%
11.19%
10.28%
9.79%
11.34%
% Asset Change
13.17%
12.02%
8.32%
4.71%
9.56%
% Sales Growth
20.21%
11.65%
8.57%
16.96%
14.35%
% Asset Change
32.60%
21.10%
0.32%
4.16%
14.55%
Family Dollar
Dollar Tree
Dollar General
% Sales Growth
12.35%
8.39%
4.90%
2.02%
6.92%
% Asset Change
12.66%
11.48%
12.03%
6.85%
10.75%
% Sales Growth
22.95%
13.91%
18.43%
% Asset Change
25.00%
8.49%
16.75%
% Sales Growth
17.40%
11.29%
7.92%
9.59%
12.76%
% Asset Change
20.86%
13.27%
6.89%
5.24%
12.90%
99 Cents Only
Industry Average
2006 Locations
Family Dollar
Dollar Tree
Dollar General
99 Cents Only
Stores Opened
305
305
300
251
Total Existing
6208
3217
8229
483
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The Five Forces Model
Michael Porter developed an analytic tool, now known as “the five forces
model”, to analyze and asses the value of an industry. The five forces model
utilizes an outside looking in view of a corporation’s or business organization’s
industrial environment to derive a conclusion of value from five different driving
forces. These forces include: rivalry among existing firms, threat of new
entrants, threat of substitute products, bargaining power of customers, and
bargaining power of suppliers.
The first three forces valuate the degree of actual competition along with
potential competition. These forces are useful in predicting whether or not there
is a market for potential deviant profits. The bargaining power in input and
output markets is analyzed through the later two forces. These forces influence
the actual profits versus potential profits. When information of an industry is
obtained and examined using the five forces model, a firm can more easily
strategize and plan for growth within the industry.
DISCOUNT VARIETY STORE INDUSTRY
Rivalry Among Existing Firms
Very High
Threat of New Entrants
Very Low
Threat of Substitute Products
High
Bargaining Power of Customers
Moderate
Bargaining Power of Suppliers
Low
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Rivalry Among Existing Firms
The intensity of competitive rivalry in an industry is determined by a
number of circumstances and varies from industry to industry. Firms in any
industry desire a competitive advantage over its competitors to get ahead. Cost
advantage and differentiation advantage are the two types of competitive
advantage. Differentiation advantage is concerned with producing benefits in
product quality that surpass the rival’s products in order to gain an edge. In the
discount variety store industry, firms focus on cost leadership because cost, not
quality, is the costumer’s concern.
Achieving a cost leadership competitive advantage in this industry will
generate deviant profits for the firm while charging the same price as
competitors. The rivalry among competitive firms can be evaluated by these
following industry characteristics (quickmba.com).
Industry Growth Rate
The discount retail industry is a very strong and established sector of the
U.S. economy. Our research would suggest that there has been a considerable
growth in the industry since 2002. The Family Dollar, Dollar General, Dollar
Tree, and 99 Cents Only went from a combined total in sales in 2002 of over 15
billion dollars, to a combined total in sales of over 20 billion dollars in 2006.
Each company has also acquired more assets in large part due to the opening of
a combined total of 6157 stores since 2002.
Most of the industry focuses on low prices and is geared more towards
low to lower middle class consumers. The increase of immigration into the
United States in recent years has increased the number of consumers that are in
these socio-economic classes thus provided more customers for the industry.
13
Such a large inflow of new consumers can be partially contributed to the
substantial increase in sales over the past five years and in years to come.
Each of the four companies researched have predicted an increase in
sales for 2007 and are in the process of opening new stores throughout the U.S.
The data analyzed would suggest that the discount store industry is growing
steadily, and shows no signs of downsizing any time soon. Firms’ competing for
market share in the due to industry growth is one aspect of the rivalry amongst
the existing variety discount stores.
The Sales Growth Chart was derived from the annual net sales reported
by each company in their respective 10-Ks. The amount of growth may have
slumped slightly, but overall this is a very healthy increase in sales for each
company and the industry as a whole. 99 Cent Only had a change in fiscal year
end and chose not to disclose enough financial data to determine an accurate
14
net sales growth.
The Asset Growth Chart illustrates there is a small difference between
companies’ assets. The percentage growth is derived from each companies
reported total assets on their balance sheets. This percentage change can give a
general idea of a company’s growth. However, in the retail industry, a large
portion of a company’s assets is comprised of merchandise inventory. This value
estimate can change drastically and be altered in a number of ways for many
reasons. Nevertheless, the industry average shows a healthy growth slowing
down from the boom in 2002-2003. Once again, 99 Cent Only Store did not
provide adequate information to derive an accurate percentage
Concentration
The relative sizes and number of firms in an industry, in relation to that
industry as a whole, is measured by the concentration ratio. The market form of
an industry is indicated by the concentration ratio. The discount variety store
15
industry is an oligopoly market structure similar to that of the automobile
industry. This is true because the concentration ratio shows that the industries 4
largest firms (Dollar General, Family Dollar, 99 Cent Only, and Dollar Tree) own
more than 40 % of the market share (10 K’s of each firm). When a few number
of firms own such a big portion of the market, that industry is said to be highly
concentrated. At this level of concentration, firms must and will compete for
success.
Market Share
The percentages displayed in these graphs were derived from the net
sales reported by Family Dollar, Dollar Tree, Dollar General, and 99 Cents Only
Store. It was not possible to compute an accurate market share for the year of
2005 because 99 Cents Only Store changed their fiscal year end. Additionally,
they did not disclose enough financial data to estimate their 2005 net sales.
16
Differentiation
When firms of an industry have low levels of product differentiation,
competition is more intense. If products and services, in an industry, are similar
or not differentiated, rivalry levels among existing firms are elevated. There is
little to no differentiation among products in the variety discount store industry.
Customers will jump from competitor to competitor to get there product because
there is not much product or price contrasts. If differentiation is absent, firms’
competing for customers is present.
Switching costs
When product differentiation is minimal, switching business from one
supplier to another is less expensive. The switching costs in the variety, discount
store industry, pertaining to the use of assets for alternative purposes, are
relatively low. Although very unlikely, a discount store could liquidate inventory
and use store space to sell auto parts, shoes or anything of the retail nature.
With store space that is already suited for selling “stuff”, switching costs are
minimal in that aspect.
Ratio of Fixed to Variable Costs
Fixed costs are costs that remain constant despite revenue earned. A
fixed cost could be wages that must be paid to employees running a firm even if
the firm’s sales dollars for the day are zero. Regardless of the revenue the
employees must be paid.
Variable costs are expenses that vary, hence the name variable, with the
amount of revenues generated. Commissions on sales are a prime example of a
variable cost. If an employee sales 100 dollars worth of product and earns 10%
commission, then the firm must pay the employee 10 dollars. Those ten dollars
is a variable cost (expense) to the firm. If the employee sells 200 dollars worth
17
of product, the firm will have a commission expense of 20 dollars which will be
paid to the employee.
When fixed costs are high and variable costs low the ratio of fixed costs to
variable costs is high. High fixed costs will cause a firm to operate at full
capacity to generate enough revenue to cover these fixed costs. When fixed
costs are diversified among a large number of units, profits will increase because
the cost of each unit will decrease.
In the variety discount store industry firms are very cost competitive.
Fixed costs are high in this industry because firms lease most of the company’s
stores. Family Dollar leases 5,719 of its 6,208 stores (FDO 10k). “Most of Dollar
General’s stores are located in leased premises” (DG 10k). Due to low prices
firms attain profits by driving costs down. Firms keep costs low by selling large
quantities (units) of products. This will diversify fixed costs. In industries where
firms must operate close to full capacity, rivalry amongst the firms increases with
the increased production output.
Excess Capacity and Exit Barriers
When an industry becomes flooded with new entrants, competition among
rival firms can cause supply to exceed the customer’s demand. If the market is
saturated and the industry growth rate slows down, there will not be too many
goods and not enough customers to consume the goods. This type of situation
is known as excess capacity. This type of “industry shakeout” can be a death
sentence to companies when exit barriers are high. Fortunately the variety
discount store industry does not foresee new entrants as a potential threat.
The degree of exit barriers in the industry determines the cost of
liquidating the product and switching industries. High exit barriers will in turn
cause firms to remain in the industry when profits are low are losses are
incurred. Industries with specialized products experience high exit barriers
where as it would not cost much for variety discount stores to liquidate products
and switch industries (quickmba.com). Firms must compete when exit barriers
18
are high. Dollar Tree, Family Dollar, 99 Cents only, and Dollar General have
been present in the industry and prospered for many years. Although the exit
barriers in the variety discount store industry are relatively low, it is not probable
that firms would exit the industry when historically, and in the fairly predictable
future, there is no reason to. Thus, it is safe to state that because the firms are
not exiting, rivalry remains high.
Conclusion
After analyzing this industry through these different aspects, the data
concludes that the variety, discount industry rivalry among existing firms is very
intense. The intensity of the rivalry within the industry will continue to maintain
an elevated level as each firm strives for a cost leadership competitive advantage
over the other firms.
Threat of New Entrants
An industry with the potential to provide deviant profits will interest new
entrants. The threat of new entrants can impact price limitations among
established firms in easily accessible industries. Depending on several
circumstances, entry into an existing firm can prove to be an easy task or an
unattainable goal. The threat of new entrants into the discount variety store
industry poses little threat on the industry.
Economies of Scale
“An economy of scale characterizes a production process in which an
increase in the scale of the firm causes a decrease in the long run average cost
of each unit (www.wikipedia.com).” The existence of such an economy of scale
is very beneficial to the variety discount store industry. Because of the large
volume or bulk of product they purchase and sale over a long period of time,
19
costs per unit remain low. New entrants would experience difficulty in keeping
prices as low as established firms because they would not have the resources to
purchase on a large scale.
Access to Distribution Routes and Supplier Sources
Discount variety store supplier relationships are scarce. The well
established firms of the industry have attained contracts with suppliers making it
difficult for new entrants to purchase products at such low prices. Suppliers
agree to these contracts because they benefit from the amount of volume they
are able to move. The buyers are able to consistently purchase massive
quantities from suppliers for low costs which is good for both players. This
proves to be a huge cost challenge for potentially new firms because of existing
supplier – discount store relationships. If costs are high, prices will elevate in
order to attain profits. Keeping costs down, which in turn keeps prices low, is
essential for entrance and survival in this competitive industry.
Legal Barriers
Complying with the laws is critical for entrance and prosperity in any
industry. The degree of the laws can prove to be a significant barrier or a minor
obstacle. Entrance into the discount variety store industry is not highly affected
by government restrictions. This does not mean that it is not a potential
obstacle for new entrants. A significant percentage of goods in the variety
discount store industry are imported. New comers must be aware of tax laws
such as those pertaining to imported goods which can negatively affect supply
pricing. Again, keeping costs down is a must in this industry, thus increased
costs are a handicap to entrance into the market.
Conclusion
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Well established supplier relationships, large economy of scale, and a few
legal barriers are all hurdles that keep the threat of new entrants into the
industry low.
Threat of Substitute Products
The threat of substitute products will always be of major concern to the
variety discount store industry. The five direct competitors in the discount
variety store industry practically offer all the same products with the same prices.
As a result, customers switching cost would ultimately be low. These factors
cause a huge threat of substitute products in the discount variety store industry.
Buyers Willingness to Switch
Customers of the discount variety store industry are generally not partial
to any particular discount store over another. Due to similar products and
pricing throughout the industry, customers will shop by convenience. Although
the targeted customer is loyal to the industry, they are more than willing to
substitute one discount vendor for another. Because of this, firms must focus on
store location in order to attract consumers.
Conclusion
Disloyal customers and firms mirroring firms in the industry causes a
significant threat of substitute products. Switching costs will always be low in
this industry so the threat of customers substituting one store for another will
always be a factor of the industry.
Bargaining Power of Customers
The fourth component of the Five Forces Model is the bargaining power of
customers. This component explains the relationship between a specific industry
and its customer. This relationship is essential. Depending on who has the
21
power over the other determines “who is boss” in the relationship. Customers
have an impact on the industries behavior such as prices of products and the
type of merchandise that the stores in the industry provides if they have power
over the company. If it’s the other way around, the industry has power over the
customer; the industry can charge any amount for the product they supply and
chose any location to ground their stores. Who has this control is a key factor of
how any industry operates its business and cost leadership strategies.
Switching Costs
Dollar General, Wal-Mart, 99 Cent Only Stores, and Family Dollar are just
some of the many discount variety stores in the United States. Many of these
companies advertise “brand names” at “low prices” and this is just the case.
Most merchandise supplied in discount stores is priced under or around ten
dollars. Since there are so many of these low-end retail stores for a consumer to
choose from, the industry is highly competitive. The price for a consumer to
switch from a Dollar General Store to a Family Dollar store is practically nothing.
Because of their similar product offering and price the primary factor in a
customer choosing one store over another simply becomes location. The closer
store the more ideal for the customer and would thus be chosen over a farther
store.
Differentiation
In the self-service discount retail industry, there is some degree of
differentiation necessary to compete within any industry, but in the discount
variety industry a strong cost leadership strategy is paramount. Though
attracting a large volume of buyers is priority. The main way that general
merchandisers try to differentiate themselves from other discount stores is by
offering brand name products for their customers, such as Tide, General Mills
Cereals, Johnson & Johnson, and Bounty, etc. Most companies in this industry
have its own brand name that is available at lower cost than leading brands in
22
stock. Coming up with new way to put them apart from the rest is some
consideration of how Family Dollar and other discount stores operate their
business.
Importance of Product for Costs and Quality
The type of target market Family Dollar and other full-line discounters are
interested in attracting is the “low to lower middle-income consumers” (Reuters).
The quality of the product is not a huge impact on the decision of the consumer.
However, cost of the product is an important criteria measure when customers
are shopping in these low-end retail stores. Customers are more interested in
how much they can get for their dollar. Private brand names that a store like
Dollar General offers are at a lower cost for their consumers compared to more
popular brands. DG Guarantee and Clover Valley are some of Dollar General
Private brand labels. Many of the discount stores have their own private brands
on their shelves.
Number of Customers
The number of customers coming into these discount stores is very
important. Discount stores place their buildings in areas where their customer
lives. An important customer to Family Dollar is “women shopping for a family
that earns around $25,000 a year” (Answers.com). The more stores a company
has in their target market the easier it is to increase customer foot traffic. Dollar
General leads the industry with about 8,200 stores in thirty-five states while 99
Cent Only Stores have only 251 stores in only four states (Hoover.com). In
return, Dollar General has higher net sales than 99 Cent Only Stores since they
are more available and convenient. Companies in this area try to come up with
fresh new ideas to bring in those customers. For example, Dollar Tree accepts
food stamps as a method of payment for their merchandise and soon enough so
will Family Dollar.
23
Volume per Customer
The amount of goods purchased by a customer brings more profit and
sales to the dollar stores. With the average customer of Family Dollar and Dollar
General spending, “just $8 and $11 per shopping trip, respectively” (Discount
Store News Dec. 8, 1986), it’s painfully apparent why the volume per customer is
essential to these discount stores. With these customers buying approximately
eight items, since most items are priced around one dollar, the more customers
that these general merchandise stores can attract the better for the company.
Conclusion
Through all of the points discussed above, it is obvious for one to see that
the bargaining power of customers for the variety discount stores is moderate.
The customers have some say as to what the stores in the discount variety
industry offers.
Bargaining Power of Suppliers
The last part of the Five Forces Model is the bargaining power of
suppliers. There are “twenty five competitors for Family Dollar Stores”
(Hoovers.com). These discount stores carry many different types of
merchandise ranging from TracFone prepaid cell phones to Tampax tampons to
Texaco anti freeze coolant, which are all offered at Family Dollar Stores.
Therefore, it is easy to understand that there needs to be a respectable
relationship between the company and its suppliers. Vikas Wai, Family Dollar’s
director of e-commerce, supports this by saying, “We need a strong relationship
with our suppliers to ensure that we can manage our inventory to keep the
prices low and the right products in stock”. Many of the full-line discounters
have private brands and national product brands stocked on their shelves.
24
Therefore, retail stores main objective is to keep costs and prices as low as
possible.
The relationship that Family Dollar has with its suppliers seems to be very
good. “The company purchases merchandise from approximately 1,400
suppliers and generally has not experienced difficulty in obtaining adequate
quantities of merchandise” (Family Dollar 10K). The company is able to have
plenty of product depth and a large volume of them to offer to their consumer.
The company wants those name brands for cheap in their stores to attract lower
income customers. Suppliers often have items that become discontinued. The
“dollar” stores come in handy and also profit by taking these discontinued items
off suppliers’ hands. The discount variety stores will always take cheap
merchandise. There are also many different suppliers to choose from in the
industry. If one supplier will not meet the need of the mass merchandise store
by means of volume or price of a product, the company will simply find other
means of filling that specific product and need. For instance, when Proctor and
Gamble refused to make a deal on Pampers for the President of Family Dollar
Howard Levine, he simply stocked more of the Kleenex brand of disposable
diapers and Family Dollar’s own brand of diapers. Soon enough, the need of
Pampers by consumers was obsolete (Answers.com). Levine had to come up
with a new idea since the deal with Proctor and Gamble failed, but still meet his
customers’ value and price expectations.
Conclusion
Since many of the discount stores deal with many suppliers, the
bargaining power of suppliers is low. If one supply will not offer the right price
for a product, the general merchandiser can easily find a supplier who will.
Value Chain Analysis
25
There are two strategies for creating a competitive advantage for any
firm: differentiation, and cost leadership. Differentiation seeks to ascertain a
novel and innovative product or service that is difficult to duplicate well or
possesses some first mover advantage. Cost leadership, on the other hand,
focuses on cutting input costs to increase profit margin. In general the Discount,
Variety Store industry adopts the latter. However, such a broad industry
encompasses a variety of firms from the humble 99 Cents Only Inc. (NDN) to the
massive Wal-Mart Stores Inc. (WMT). To get a better understanding of who
competes most directly with Family Dollar Inc. (FDO) the industry must be
broken down further. FDO and to other “dollar” chains operate in the, “general
merchandise and retail store” (FDO 10-K 2007), segment that provides,
“primarily low to lower-middle income consumers a wide range of competitively
priced basic merchandise in convenient neighborhood stores.” (FDO 10-K 2007).
Once broken down it is obvious that the “dollar” stores do not compete on the
same level as the super centers. It is also much clearer that in a sub industry
which thrives almost entirely on thrift, why a strong cost leadership strategy that
emphasizes economies of scale, reduced input costs, low-cost distribution, and a
tight cost control system, is a staple for long-term success.
Economies of Scale
In any large retail business economies of scale play some role as part of a
cost leadership strategy. In the discount variety industry companies live and die
by economies of scale. Economies of scale arise and become increasingly
apparent as a company grows. In the retail industry the bigger the order the
lower, “the average cost per unit since fixed costs are shared over an increased
number of goods” (investopedia.com). Not this entire concept is based on
production and order capacity, however. Much is politics in the form of
relationships with the suppliers as discussed in the prior sections. A firm that
makes efficient use of its economies of scale will, in principle, be able, “to earn
above-average profitability by merely charging the same price as its rivals.”
26
(Palepu, 2-9) and when most of your products retail in a, “range from under one
dollar to ten dollars” (FDO 10-K 2007), any weakness in this area becomes
painfully apparent on the bottom line.
Reduced Input Costs
In the Discount, Variety Store industry the inputs in the value chain are
not the same as in the manufacturing industry. Instead of raw material and
manufacturing processes the inputs that make up the variety store industry focus
on property purchasing and renovations, frugal advertising, and wages.
The majority of the firms in the discount retail segment lease their store
locations as opposed to buying them out right. This allows leases that are,
“relatively low-cost, short-term leases (usually with initial or primary terms of
three to five years) often with multiple renewal options.” (Dollar General 10-K
2007). In the unlikely event that a new store is built or bought, it is treated as a
valuable investment and all parameters of the construction or sale are
vehemently researched prior to completion.
In an effort to keep profit margins elevated in accordance to a cost
leadership strategy, all of the “dollar” store chains are misers when it comes to
the advertising budget. At Dollar General, for instance, “Advertising expenses
remained less than 1% of sales.” (Dollar General 10-K 2007), for the 2007 fiscal
year. The other players of the discount retail segment keep their advertising
budgets at comparable levels. To keep these budgets in check most “dollar”
stores abandon television and radio spots in favor of much cheaper and more
local paper circulars that contain various coupons and promotions. Limited radio
advertising is utilized only for new store openings in metropolitan areas, and
during the holiday season.
As with most any industry, the most expensive of all the operating
expenses are the employees. From wages to fringe benefits they represent one
of the largest strains on a firm’s gross income. The discount variety industry
manages these in two important ways. Firstly and most obviously, they staff
27
their stores and distribution centers with the absolute minimum number of
employees to keep them operating efficiently, without fracturing any state and/or
federal labor standards legislation. Seasonal help is also used to maintain
operational efficiency during peak sales periods throughout the year without
putting a strain on company resources during non-peak periods. The second
facet in keeping wage expense low is to maintain a positive relationship with
employees to prevent unionization. Currently among the nationwide “dollar”
store chains, “None of the employees are subject to collective bargaining
agreements.” (Dollar Tree 10-K 2007), thus saving the companies the substantial
costs of abiding by such agreements.
Low-Cost Distribution
In an industry that depends on the availability of goods to sell while
maintaining a cost leadership strategy, cost-effective product distribution is of
the utmost importance. The present industry norm for nation-wide companies
are to employ both company owned trucks and privately contracted carriers in
tandem to replenish stores. These trucks are deployed from strategically placed
warehouses that are, “designed to improve inventory flow to consumers” (Dollar
General 10-K 2007). This method has proved itself in many industries prior to
the discount retail segment and has only just recently been deployed in the
“dollar” store business with great success. The deployment of a supply chain
with this level of efficiency is essential to satisfy the recent growth of the
discount variety industry, “dollar” stores in particular.
Cost Control: A Conclusion
All of the afore mentioned points are integral parts of a tight cost control
system. The absence and/or deficiency in any one of these parts will place a
company, within the discount variety industry, at a disadvantage compared with
a company that successfully implements a said strategy. Because of this
industry’s emphasis on cost control as a means of survival, a firm that ignores
28
this theory will soon find itself downsizing, bankrupt, or under new ownership.
This leaves the remaining firms that can survive in such a competitive
environment, continually seeking ways to grow profit margins. In this highly
concentrated industry segment, stealing market share is becoming increasingly
difficult. As a result, cost control strategies present the most viable option for
companies within the industry to grow profits.
Firm Competitive Advantage Analysis
The discount, variety store industry, “in which the Company [Family Dollar
Inc.] is engaged is highly competitive.” (FDO 10-K 2007) and highly
concentrated. Being such, FDO has adapted their own version of the cost
leadership strategy in order to maintain a competitive advantage. FDO sees their
main competitive factors as, “store locations, price and quality of merchandise,
in-stock consistency, merchandise assortment and presentation, and customer
service.” (FDO 10-K 2007). As such, their cost leadership strategy concentrates
on: economies of scale, reduced input costs, low-cost distribution, and a tight
cost control system.
Economies of Scale
Economies of scale play an important role in any retail chain whether it be
a hardware store or a specialty retailer, like an auto parts store. Family Dollar
Inc. knows the importance of economies of scale and as such has a considerable
supply chain that, “purchases merchandise from approximately 1,400 suppliers”
(FDO 10-K 2007). This large network of suppliers not only keeps the price and
quality of merchandise above industry standards, but adds a degree of depth to
FDO’s product lines. FDO also has the fact that it is one of the leaders of the
“dollar” store industry, in terms of market cap and quantity of store locations,
working in its favor. FDO has a significantly increased buying power and the
29
bigger the order the lower, “the average cost per unit since fixed costs are
shared over an increased number of goods” (investopedia.com). FDO also limits
the influence of their suppliers by allowing, “No single supplier to account for
more than 9% of the merchandise sold” (FDO 10-K 2007), by FDO in a single
year. This check on the power of suppliers and their sheer size, helps FDO keep
the economies of scale in their favor.
Reduced Input Costs
As Family Dollar Inc. is a retailer, they do not have the typical inputs of a
manufacturing company. Instead of raw materials FDO has less conventional
inputs that comprise their value chain. The inputs that make up the variety store
industry focus on property purchasing and renovations, frugal advertising, and
wages.
FDO leases the majority of their store locations as opposed to buying
them out right. This allows fewer long term maintenance and upkeep costs
while affording the opportunity to easily switch to more lucrative markets at the
culmination of the lease agreement. In addition, all, “stores are operated on a
self-service basis” (FDO 10-K 2007), which means that customers enter the store
and primarily help themselves with little intervention from the minimal sales
staff. The goal herein is to keep overhead as low as possible with only a slight
sacrifice to customer service.
Family Dollar Inc. like most other companies in the same industry keeps
advertising costs to a minimum. They are able to do this while still attracting
new customers, solely by the considerable bargains they offer their lower income
customer base. To supplement their word-of-mouth advertising, FDO also,
“advertises through circulars available in stores or, occasionally, circulars that are
inserted in newspapers” (FDO 10-K 2007). In the recent past FDO has also
introduced a “Treasure Hunt” merchandising campaign that involves further
reduced prices on select products that are “hidden” throughout the store; all this
to induce excitement among shoppers and increase repeat customers.
30
Family Dollar Inc. is a relatively large company that requires a large labor
force, specifically, “approximately 24,000 full-time employees and approximately
20,000 part-time employees” (FDO 10-K 2007), to operate smoothly. This
substantial labor force must be maintained while trying to keep overhead at the
lowest possible level. To accomplish this, FDO has divided their 44,000 person
labor force up over, “6,200 general merchandise stores” (FDO 10-K 2007), and
nine distribution centers which computes to an average of slightly over seven
employees per establishment. Take into consideration that the average size of
one of their general merchandise stores is, “approximately 7,500 to 9,500 square
feet” (FDO 10-K 2007), not including distribution centers, and it becomes evident
how important it is to keep payroll to a minimum.
Low-Cost Distribution
In the discount, variety store industry, product logistics like any other
input, must be run efficiently, to maintain a cost leadership strategy. To do this
Family Dollar Inc. has roughly 6.5% of its merchandise, “shipped directly to its
stores by the manufacturer or importer.” (FDO 10-K 2007), saving FDO the costs
associated with having the same products shipped using their resources. The
remaining proportion of merchandise is shipped via company-owned trucks or
contracted common carriers. Before that merchandise is shipped by company
and common carrier trucks, it travels to one of nine distribution centers which
are strategically placed around the United States to minimize distance between
the warehouse and the stores served.
31
Number and Average Distance of Stores Served by Each DC
Distribution Center
Number of Stores Served
Avg. Distance (Miles)
Matthews, NC
West Memphis, AR
Front Royal, VA
Duncan, OK
Morehead, KY
Maquoketa, IA
Odessa, TX
Marianna, FL
Rome, NY
Total
708
679
756
779
701
781
662
628
479
6,173
159
264
200
314
201
294
566
267
222
276
(FDO 10-K 2007)
In addition to their optimal locations, the distribution centers utilize, “highspeed sortation systems” (FDO 10-K 2007), and computer based perpetual
inventories at every store, to keep in-stock consistency and merchandise
assortment at unparalleled levels. All of these items working in unison keep the
distribution cost per unit among the lowest in the industry.
A Tight Cost Control System
All of the afore mentioned elements, from the economies of scale to the
low-cost distribution are essential rudiments of Family Dollar Inc.’s cost control
system. However, like any competitive firm, FDO supplements these foremost
elements with other, more subtle, cost-cutting techniques. Chiefly, the relatively
small size of the typical FDO store allows FDO to utilize older, more economic
strip-mall locations rather than incurring the property and building expense for
32
the construction of stand-alone stores. The utilization of strip-mall locations also
affords FDO the option to take over existing business chains that also frequent
this type of real estate at a significant cost savings versus purchasing the same
locations individually. Finally, FDO’s, “Vendors’ trade payment terms are
negotiated to help finance the cost of carrying” (FDO 10-K 2007), added
inventory; in other words FDO gets an even deeper discount to take delivery of
larger-than-needed quantities or slow selling merchandise.
On The Horizon
There is no question that in being a low-cost retailer Family Dollar Inc. has
adopted a cost leadership strategy instead of one based on differentiation. This,
however, does not mean that FDO hasn’t integrated clever differentiation
techniques to keep competitors one step behind. As part of their, “multi-year
“store of the future” initiative, the Company is installing new point-of-sale
systems that will allow it to accept a broader range of tender types, including
food stamps” (FDO 10-K 2007), and non PIN-based credit cards, which the
Company currently does not accept. These added offerings, especially the ability
to accept food stamps, will no doubt increase customer traffic given the lowincome clientele that FDO caters to. FDO also plans, “to install coolers in
approximately 1,200 additional stores.” (FDO 10-K 2007), to broaden product
offering to include many common perishable grocery items. All of this is an
effort to pull customers out of competing chains and thus, gain valuable market
share in an otherwise saturated industry.
33
Accounting Analysis
The second step in a business valuation and analysis is an accounting
analysis. In order to understand the intrinsic reality of the business, one must
understand the degree to which a firm’s accounting reports reflect such. Firms
have the opportunity to distort accounting numbers in order to make the
business more appealing to investors. An accounting analysis will “evaluate
accounting quality by assessing accounting policies and estimates” (Palepu Healy
2008).
Executing an accounting analysis involves a series of steps. The first step
is to identify the key accounting policies that a firm chooses to represent the
risks and success components of the business. Step two involves assessing the
accounting flexibility. Managers’ degree of flexibility differs among firms
depending on rules and regulations. Generally speaking, the more flexibility a
manager is granted in choosing accounting policies, the more informative the
accounting numbers are to an investor, pertaining to the economics of the firm.
Step three in the analysis of accounting is to evaluate the accounting strategy
the firm has chosen. Strategies will vary depending on the manager’s flexibility
and whether or not the firm is trying to cover up actual performance or provide
to the outside the economic standing of the firm. Evaluating the quality of
disclosure is the next step in the accounting analysis process. There is a
minimum disclosure requirement by law, so it is important to determine the
quality of the disclosure by concluding if a firm reported beyond the minimum or
not. The fifth and sixth steps are composed of identifying potential “red flags”
and undoing the accounting distortions respectively (Palepu Healy 2008).
34
Key Accounting Policies
Family Dollar’s key success factors (KSF’s), as identified in the Firm
Competitive Advantage Analysis, are economies of scale, reduced input costs,
low-cost distribution, and a tight cost control system. These KSF’s are in line
with FDO’s competitors as well, albeit they have their own methods for achieving
a cost leadership strategy. All four of the KSF’s are geared toward reducing
costs which is in line with FDO’s and the industry’s strict cost leadership strategy.
This emphasis on cost leadership spawns the following Key Accounting Policies
(KAP’s) for the “dollar” store industry: lease treatment, merchandise inventories,
intangible assets (particularly goodwill), and employee retirement programs.
Lease Treatment
The retail industry as a whole has a potentially huge liability related to
their store locations. Every one of the large “dollar” store chains leases the
majority of their store properties (FDO 2007 10-K, DLTR 2007 10-K, NDN 2007
10-K), even if most own their distribution centers. These leases can be treated
in one of two ways, as operating leases or as capital leases.
Operating leases treat lease payments as rent that is expensed when
incurred. Family Dollar uses this method because it keeps these expenses of the
balance sheet and recognizes these expenses much later. In addition, operating
lease terms are generally shorter than capital lease terms. This allows FDO to
more quickly vacate overpriced lease contracts for more cost effective leases
which is in line with its emphasis on cost leadership.
Capital leases are similar to mortgages from a financing perspective.
They do affect the balance sheet and both short and long term liabilities. Unlike
35
FDO, Dollar Tree and 99¢ Only do show capital lease liabilities on their respective
balance sheets. Dollar Tree’s capital lease obligation for 2007 was $400,000
compared with an operating lease obligation in the same year of $284 million
(DLTR 10-K 2007). Ninety-nine Cent Only’s total capital lease obligation in 2007
was $699,000 compared with a total operating lease obligation of $196 million
(NDN 10-K 2007). These figures show that the “dollar” store industry heavily
favors the use of operating leases due to the fact that they keep significant
liabilities of the balance sheet and their compatibility with the cost cutting KSF’s.
Operating and capital lease will be discussed in detail in the “Potential
Accounting Flexibility” section.
Merchandise Inventories
Merchandise inventories represent the second KAP because they make up
such a huge part of the total assets of retail stores.
Merchandise Inventory as a percentage of
Total Assets
2007
2006
2005
$
605.00
$
1,873.30
$
576.60
$
1,798.40
$
615.50
$
1,792.70
DLTR (millions)
Merchandise Inventory
Total Assets
Percentage
32%
32%
34%
NDN (thousands)
Merchandise Inventory
Total Assets
Percentage
$
152,793.00
$
643,135.00
$
139,901.00
$
628,708.00
24%
$
147,609.00
$
629,611.00
22%
23%
FDO (thousands)
Merchandise Inventory
Total Assets
Percentage
$
$
$
1,065,898.00
1,037,859.00
1,090,791.00
$
$
$
2,624,156.00
2,523,029.00
2,409,501.00
41%
41%
45%
36
Dollar General (thousands)
Merchandise Inventory
Total Assets
Percentage
$
$
$
1,432,336.00
1,474,414.00
1,376,537.00
$
$
$
3,040,514.00
2,980,275.00
2,841,004.00
47%
49%
48%
Consistency in these figures is more important that growth, as growth can
represent inefficiency in the Day Supply of Inventory and Inventory Turnover
metrics. Also, any unnecessary growth in inventory is an increase is an expense
as it costs money to carry additional inventory. A slight decline in the
percentage figures is positive in the discount store inventory and runs parallel to
a tight cost control KSF.
Goodwill
Goodwill is the third KAP because Family Dollar and its direct competitors
chain stores and always looking for cheap expansion. The easiest way for them
to expand is to purchase slower growing chains, or acquire, “store leases
through bankruptcy proceedings” (DLTR 10-K 2007). These purchases allow for
goodwill to find its way on to the balance sheet as an asset. Neither Family
Dollar nor 99¢ Only record any goodwill, even in their “other asset” sections of
the balance sheet, according to their respective 10-K’s. Both Dollar Tree and
Dollar General do, however, record goodwill as an asset on the balance sheet.
While Dollar Tree’s disclosure is very good, with a separate line item displayed
for goodwill, Dollar General lumps their goodwill in with the “other assets”
section of their balance sheet. Investors must beware of any goodwill as it is
aggressive accounting because it inflates assets but usually does not provide any
revenue for the company.
Retirement Programs
37
The final KAP for the “dollar” store inventory is employee retirement
programs. FDO and its competitors are required to have a “voluntary
compensation federal plan, under section 401(k) of the Internal Revenue Code”
(FDO 10-K 2007). Even with a strictly voluntary program, the company’s
required investment in such plan can be substantial given the large number of
workers employed by retail chains. All retirement contributions by their
respective firms were available in the 10-K’s for at least three years; however,
even when Dollar Tree, which paid the most contributions, with $16.8 million
being paid out in 2007, this number was only 0.423% of their $3.9 billion in net
sales for 2007. Judging from this figure it becomes clear that the “dollar” stores’
goal of low cost keeps these retirement contributions to a minimum. The three
other companies analyzed were significantly below 0.423% as a percentage of
net sales. While, retirement programs could potentially represent a significant
cost to the “dollar” stores, their relatively small size and good discloser keep their
affect low.
Conclusion
The firms of the discount retail industry measures success by their ability
to implement a strong cost leadership strategy. The Key Accounting Policies for
Family Dollar and its competitors are based off the Key Success Factors of a cost
leadership strategy. Careful attention must be paid to the KAP’s, especially
leasing and merchandise inventories, when evaluating the quality of financial
statements. Fortunately disclosure is relatively good for all the KAP’s excluding
the leasing and goodwill sections for some companies.
Potential Accounting Flexibility
38
In the early 21st century the failure of several fortune 500 companies, due
to exceedingly “flexible” accounting practices, caused a wave of federal
legislation. This new legislation gave the Securities and Exchange Commission
(SEC) more power to police fraudulent and unethical accounting. In accordance
with new laws, like the Sarbanes-Oxley Act of 2002, all companies were required
to report with a higher degree of disclosure than before. Despite this new
legislation; however, Family Dollar, like the rest of the major players in the
discount, variety segment, still has the potential to add biased and/or speculative
data to its financial statements. This additional information can either serve to
add value and practical substance to the accounting statements, or serve as a
shroud to keep outsiders ignorant of the company’s true financial condition. The
areas that most often are subject for flexible accounting in the discount, retail
segment are: lease treatment, merchandise inventories, intangible assets
(primarily goodwill), and retirement programs.
Leases
Most of the potential for accounting flexibility in firms that operate large
retail chains comes from a few particular items. In companies that have such a
large proportion of operating income tied up in store locations and property,
lease treatment becomes the most significant of these items. Generally
Accepted Accounting Principles (GAAP) requires that these leases be reported in
one of two ways: as operating leases or as capital leases. Family Dollar’s use of
leases will be discussed in detail later.
Operating Leases
The operating lease is generally utilized for short term leases (5 years or
less) and as there is no transfer of ownership the rent is expensed when incurred
as a necessary cost of doing business. The lessee pays for the right to use the
lessor’s property as a place of business. Because the rent in this type of lease is
expensed it never shows on the balance sheet and only impacts the income
39
statement. This treatment of the leases has the potential to significantly
understate liabilities and inflate retained earnings.
Capital Leases
Capital leases, in contrast, are typically used for long term leases (10
years or more) and treat the asset as if it were being purchased by the firm. A
long-term asset is placed on the balance sheet with a corresponding entry being
made to long-term liabilities. Although not used by Family Dollar Inc. for any of
their retail stores because expenses are recognized so much earlier, capital
leases do offer some unique benefits. They afford to company the right to,
“claim depreciation each year on the asset and also deduct the interest expense
component of the lease payment each year.” (pages.stern.nyu.edu). They also
can boost the CFFO of a firm that opts for a capital lease over an operating lease
because the capital lease payments are divided between operating and financing
activities, while operating lease payments show as cash outflows from
operations, (Investopedia.com).
Merchandise Inventories
The second major area for potential accounting flexibility in the discount,
retail industry arises in the merchandise inventories item of the balance sheet.
Not surprisingly the merchandise inventories makes up a significant, if not
dominant, proportion of current assets on the balance sheets of chains that
make all their money selling merchandise. In 2006, Family Dollar’s merchandise
inventory accounted for 41% of total assets (FDO 10-K 2007). There is so much
room for flexibility in this component because not this entire inventory remains
sellable all of the time. Food perishes, trends subside, technology causes
obsolescence, and things break. How and whether or not a firm impairs or
writes down these assets after such occurrences determines the transparency
and usability of its financial statements. The “dollar” stores have the luxury of
not having to dwell on advancing technology and trendiness as the goods they
40
sell are neither high-tech, nor high fashion. They also have the unique
advantage of purchasing other companies unwanted merchandise at deep
discounts making a positive margin very easy to attain. The “dollar” stores do,
however, have to worry about perishables and damaged goods. Perishables are
becoming an increasing concern of the “dollar” store, especially with the advent
of refrigerated coolers which has greatly expanded to amount of amount of these
goods that the stores keep in inventory.
Goodwill
The frequent acquisitions of smaller or struggling retail stores and chains
that compete in the same segment as the nationwide retailers affords many
opportunities for goodwill to be recorded. This represents the third area of
potential flexibility. Family Dollar, unlike its competitors, does not recognize any
goodwill. When goodwill is recognized it is treated as an intangible asset on the
balance sheet and according to FAS 142, 2001 this asset need not be amortized,
but simply tested annually by the company for impairment (Investopedia.com).
This allows goodwill to be kept on the books till the respective company decides
otherwise; this presents a potential problem because there is no real way to
subjectively and objectively measure the market value of this goodwill. As a
result, it can serve as a booster seat that falsely inflates firms’ assets, retained
earnings, and earnings per share making it look much more attractive to
potential investors.
Retirement Plans
Pensions or compensation deferral plans represent the final area that is
most often subject to flexible accounting by firms in the discount retail business.
While these plans are offered to employees on a strictly voluntary basis, potential
problems arise when companies use too large a discount rate to calculate the
present value of future obligations. This estimation error in the discount rate will
understate the present value of the future obligation the company has to its
41
employees in a defined benefit plan. Future expenses associated with these
pension plans will far out pace the growth of funds that the company has
invested to match against these expenses leading to a shortfall between
revenues and expenses in the future.
Actual Accounting Strategy
Overview
The analysis of a company’s actual accounting strategy involves both
determining the transparency of its financial statements as high or low
disclosure, and evaluating how aggressively or conservatively it utilizes its
accounting flexibilities in the Key Accounting Policies. A high disclosure
company’s financial statements will contain a wealth of data that divulges the
true financial disposition of the company, both good and bad, to the public
regardless of any effects on stock price. High disclosure financial statements will
contain an unconsolidated balance sheet, income statement, statement of
retained earnings, and statement of cash flows accompanied by detailed notes to
the financial statements. Conversely, low disclosure financial statements report
limited information using consolidated accounting statements, which can
potentially mask the financial shortfalls of the company. They often bury the
pertinent information deep within a complicated set of notes to the financials
leaving much to be desired by investors. A company that uses its accounting
flexibilities in an aggressive manner will boost assets, while minimizing liabilities
and expenses in order to pad the financials and ultimately improve net income.
A company practicing conservative use of its accounting flexibilities will
42
depreciate assets, and perform write-downs, regardless of the effects on net
income. It is important to note that neither are the correct way and that
extreme use of either aggressiveness or conservatism will degrade the quality of
the financial statements.
Level of Diclosure
Family Dollar Inc. (FDO) reports with a high degree of disclosure, which is
in line with the rest of the companies in the industry segment. Their financial
statements are complete and readily accessible to the public. Although FDO
displays consolidated accounting statements in their 10-Ks, they are always
accompanied by a comprehensive set of notes. It is important to note that no
major discrepancies were found in almost any of the danger zones for
accounting flexibility. FDO does not record any goodwill or any other intangible
assets for that matter. Also, sales growth and inventory levels have grown
together which suggests that FDO keeps its inventory assets at acceptable levels
to meet a genuine growth in customer base; not just growth in inventory which
could be a harbinger of substantial inventory write-downs in future periods.
FDO’s does have a voluntary employee retirement plan; however, the company’s
contribution expense related to this plan was less than 2% of net income for the
last three fiscal years and properly disclosed in the financial notes (FDO 10-K
2007). FDO’s lease reporting is the last of the disclosure areas and, coincidently,
the only area that FDO seems limit their disclosure. They appear to finance most
of their store expansion and property acquisition using a leaseback method. This
information is displayed in the notes to the financial statements, but significant
computation is required to compute the magnitude of potential liabilities that are
kept off the books by using this method. A complete estimation of these latent
liabilities is performed later in the “Undo Accounting Distortions” section of this
report.
Conservative/Aggressive Accounting
43
As could be derived from its relatively good disclosure in financial
statements, Family Dollar Inc. takes a more conservative disposition on much of
its Key Accounting Policies. As prior stated FDO’s inventory and asset growth
has stayed in line with sales growth and even decreased compared with sales
growth in fiscal 2005 to 2006.
Comparison
2002-2003
2003-2004
2004-2005
2005-2006
Company Average
% Sales Growth
14.11%
11.19%
10.28%
9.79%
11.34%
% Asset Change
13.17%
12.02%
8.32%
4.71%
9.56%
Family Dollar
This can be interpreted as streamlining inventory forecasting and
replenishment systems. While a decrease in overall asset could be seen as
negative, when the decrease is primarily in merchandise inventory this leads to
an increase in inventory turnover which is generally positive and on the
conservative side. FDO does not have any goodwill recorded on the books but
they have acquired other smaller chain and thus, have had the opportunity to
recognize goodwill. The fact that they do not recognize this is a sign of
conservatism because it does not drive up assets. Pensions are recorded in the
notes but to not represent a significant expense for FDO. Lease treatment is the
only KAP that FDO reports aggressively. The lease obligations for the leaseback
financing if capitalized would nearly quadruple their long term liabilities of $329
million. A figure of this magnitude would change the entire outlook of the
financials, not to mention many of the diagnostic ratios, current ratio and quick
asset ratios in particular. The only redeeming factor is that leasebacking of this
extent is the norm for the main competitors of FDO and becoming a norm for
44
any high-growth industry with substantial amounts of PPE.
Conclusion
Family Dollar Inc.’s transparency and disclosure are generally very good.
Conservatism is practiced for most of the Key Accounting Policies and throughout
the financial statements. The only area where conservatism and disclosure are
lacking is that of lease treatment. This can and should conjure some
apprehensiveness by investors, but is not abnormal for the industry.
Quality of Disclosure
Qualitative Analysis
The Family Dollar overall has presented its financial statements with
formidable disclosure and transparency. Throughout the financial statements
there are many notes thoroughly explaining key company policies and reasons
for the information given. From 2002 to 2006 this has been consistent and not
much has changed with the way the company chooses to disclose, and to the
extent in which they choose to disclose key financial information.
One example of open disclosure and transparency throughout the financial
statements is where the company openly discusses and illustrates stock option
compensation for management, based on performance. This benefit to the
employees could prove to be a potential reason for noise in the way
management reports its numbers. This would be considered to be decision useful
information in the evaluation process. If incentives are given for a managers’
performance, they might be tempted to inflate profits or possibly modify the
financial numbers in order to increase their bonuses. Given the companies’
openness regarding management compensation and stock options down to exact
numbers, it makes it easier for an investor to derive their own opinion about the
potential problems associated with the issue.
45
Another example of good quality of disclosure is the companies’ open
discussion of all litigation in detail. In 2006, litigation the company was involved
in was discussed many times throughout the financial report. The effect of the
litigation was openly disclosed at 45 billion dollars. This disclosure is a very
important component for a valuation. The Family Dollar has been in one
particular law suit since 2001. Information concerning the progress of the suit
has been openly discussed throughout the years. With ongoing litigation, it is
important to know if there are going to be any further expenses in time and
money of the company to rid of the charges, and if so , does the company have
the resources to take care of the problem.
The Family Dollar also discusses current operating leases in detail. Most of
the stores are leased and very few are owned by the company. A large part of
the stores that are leased “provide for contingent rental payments based upon
percentage of store sales.” (Family Dollar 10k) This usually means that the more
profitable the individual store is, the more the rent will be, and the less profitable
the store is the less the rent will be. Even if the rent is lowered due to low sales
of the store, there is almost always a base rent fee. This could be considered to
be one part of the financial statements that is “cloudy” so to speak. The Family
Dollar doesn’t break down each individual stores’ rent expenses on the
companies’ income statements, rent expenses are reported as a lump sum.
Having fluctuating lease payments might create flexibility in the company’s
choices in reporting expenses to their advantage.
Conclusion
Overall, The Family Dollar has disclosed most of its financial data with
decent transparency and detail. Every step of the financial statements are openly
discussed and are in an easy to follow format, making it less difficult to browse
through the information. The fact that the reasoning behind the companies’
choice of reporting something can be found directly under the statements,
makes it easier for investors to diagnose the numbers given in the financial
46
statements. The Family Dollar is much more open with their information than
their competitors tend to be, which in turn might make an investor more
comfortable investing in the company, if everything else was held equal.
Quantitative Analysis
The following analysis will look at core revenue diagnostics and core
expense diagnostics. These ratios play an important role analyzing a company’s
quality of disclosure because they can provide indirect evidence of any
accounting distortions there may be. If there is a gross inconsistency when
company is placed side-by-side with competitors, further research is wise.
Revenue diagnostics
Possible Revenue diagnostics include net sales/cash from sales, net
sales/net accounts receivable, net sales/unearned revenue, net sales/warranty
liabilities, and net sales/inventory. The only diagnostic valid in our analysis is net
sales/inventory. All other denominators mentioned previously are not reported or
do not exist in this industry.
Net Sales ratio (net sales/inventory)
This ratio shows how net sales are supported by inventory. In this
industry, inventory control is usually not a priority. Firms in this industry do not
have a large value of inventory on hand at any time. A spike in this ratio may not
47
even represent a manipulation. This ratio is not very helpful in the quantitative
analysis.
The graph shows no spikes and therefore no reason to suspect tampering. Each
company has a relatively steady ratio of net sales to inventory.
Conclusion
The only core revenue diagnostic that is valid here is the net sales ratio.
However unimportant this ratio is, it is the only revenue diagnostic we were able
to compute. Sales divided by cash collection would have been an ideal ratio to
compute and compare because it is a very common indirect indicator of revenue
manipulation. Unfortunately, Family Dollar and other firms in this industry do not
disclose line items: cash from sales, net accounts receivable, unearned revenue,
or warranty liabilities.
Expense diagnostic ratios
48
Expense diagnostics help determine the believability of reported expenses
as they appear on various financial statements found in every 10-K. Possible
expense diagnostics include: asset turnover, raw and change form of
CFFO/NOA, raw and change form of CFFO/OI, total accruals/change in sales,
pension expense/SG&A, other employment expenses/SG&A. Total accruals
cannot be computed with the given information. Also, no companies in this
industry disclose pension expenses or other employment expenses.
Asset Turnover: (Net Sales / Total Assets)
The asset turnover ratio is computed by divided net sales by total assets.
This ratio shows how assets support net sales. A higher asset turnover ratio is
favorable. Most companies in this industry use operating leases to run their
stores rather than capital leases. This can be deceiving because a capital lease
would show up on a balance sheet as an asset. Operating leases allow a
company to report a rent expense on the income statement. Family Dollar is no
different and uses operating leases for the majority of their stores. The
capitalizing of operating leases will be shown and explained in the accounting
distortions section. Family Dollar’s corrected Asset Turnover using capital leases
is displayed in the graph. There was an increase in Total Assets, which led to a
lower ratio. This is a classic example of “off balance-sheet financing” to favorably
display financial indicators.
49
Cash Flow From Operations / Net Operating Assets:
Cash flows from operations, found on the cash flows statements, divided
by net operating assets, found on the balance sheet, shows how well a company
utilizes its property, plant, and equipment. The graphs show that Dollar Tree has
the highest ratio that steadily increases. Family Dollar’s ratio decreases slightly in
2003 and 2005, but stays relatively the same. The higher the ratio, the better a
firm utilizes its PP&E to generate cash. Dollar Tree seems to perform the best.
There is no revision needed for this diagnostic as CFFO and NOA were not
affected by our capital lease corrections.
50
Cash Flow from Operations / Operating Income:
Cash flow from operations divided by operating income, also known as
EBIT (earnings before interest and taxes) is used to measure a firm’s
profitability. This diagnostic can be very useful in the core expense manipulation
process. This diagnostic will show whether or not cash flows from operations are
51
being reported accurately to operating income. Family Dollar had the highest
ratio until 2005 when Dollar General took the lead. 99 Cents Only Store did not
disclose enough accurate information to compute a ratio. There is no reason for
suspiction in this ratio.
52
Conclusion
When we first computed Asset Turnover, Family Dollar had the highest
ratio by far. Upon further research, it was found that Family Dollar had used
operating leases that allowed for huge amounts of liabilities to not be
recognized. This was the only ratio that aroused a concern.
Potential “Red Flags”
After viewing Family Dollar’s 10K’s, the only true potential red flag found
on the financial statements is the recording of operating leases. When
companies use and record operating leases, they are usually only occupying the
location for three to five years. When using an operating lease, financial
statements only show it as an expense depreciated on a straight-line basis. After
the time allocated, the company can choose to renew their lease with the lessor.
So, the company could end up using the building for all of its useful life after all.
This should then be recorded as a capital lease, but isn’t with Family Dollar,
which is a red flag for the company.
Undo Accounting Distortions
As is the norm in this Industry, Family Dollar has many accounting tricks
to keep liabilities off the balance sheet and maximize reported profits. This is
commonly referred to as “off balance sheet financing.” The 10-K itself states that
besides the corporate headquarters and distribution centers, almost all business
done by Family Dollar occurs in buildings under operating leases. This grossly
distorts the valuation of Family Dollar and requires a correction that will
53
significantly alter the financial statement. Any operating leases that are
considered long-term need to be capitalized as Capital Assets. In simple terms,
lease (rent) payments categorized under operating expenses will be adjusted and
categorized as financing expenses. This is the proper treatment of long-term
leases because such large liabilities and assets must be reported to truly reflect a
firm’s financial position. The process of capitalizing operating leases will be
explained with the aid of the following tables. After this adjustment, a domino
effect will change financial statements, financial ratios and other important
indicators of value and profitability. Family Dollar owns less than 500 stores while
the other 6,000 are operated under lease agreements. According to the 10-K, the
majority of these leases have initial terms of five to ten years with an option to
renew for another five years. In essence, Family Dollar is able to “rent” their
business locations where almost all their sales and profits are created.
To make the most accurate estimation of capitalizing operating leases, the
present value of reported lease obligation payments must be calculated. This
method is accurate because operating leases are contractual agreements to
make rent payments each year for a specified number of years. This allows one
to compute the present value of reported rent expenses or contractual
commitments in a firm’s 10-K. The quick and easy method would be to use the
total contractual obligations reported in a firm’s most recent 10-K and divide it by
the estimated life of the leases which may or may not be reported. We used a
more accurate approach by researching Family Dollar’s lease commitments in
each year. This allowed for very accurate rent expenses because they were
updated each year. Family Dollar only reports five years of obligations and an
item line labeled “thereafter” This makes it difficult to estimate how many more
years to carry out the commitment since no specific amount of useful life years is
disclosed. Using separate tables for each year allows us to observe a declining
commitment and accurately estimate the remaining years. We used a discount
rate of 5.33% because it is our observed long-term debt rate (FDO 10-K 2007)
54
2001 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
2002
1
$141,579
2003
2
$124,267
2004
3
$100,980
2005
4
$73,886
2006
5
$43,864
2007
6
$38,965
2008
7
$38,965
Total PV of Operating Lease
PV Factor
0.949397133
0.901354916
0.855743773
0.812440684
0.771328856
0.732297405
0.695241056
Expenses:
Present Value
$134,414.70
$112,008.67
$86,413.01
$60,027.99
$33,833.57
$28,533.60
$27,089.72
$482,321
2002 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
2003
1
$169,240
2004
2
$146,652
2005
3
$118,929
2006
4
$87,770
2007
5
$54,982
2008
6
$51,375
2009
7
$51,375
Total PV of Operating Lease
PV Factor
0.949397133
0.901354916
0.855743773
0.812440684
0.771328856
0.732297405
0.695241056
Expenses:
Present Value
$160,675.97
$132,185.50
$101,772.75
$71,307.92
$42,409.20
$37,621.41
$35,717.66
$581,690
2003 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
2004
1
$190,840
2005
2
$167,434
2006
3
$136,444
2007
4
$102,997
2008
5
$67,204
2009
6
$65,823
2010
7
$65,823
Total PV of Operating Lease
PV Factor
0.949397133
0.901354916
0.855743773
0.812440684
0.771328856
0.732297405
0.695241056
Expenses:
Present Value
$181,182.95
$150,917.46
$116,761.10
$83,678.95
$51,836.38
$48,202.01
$45,762.85
$678,342
2004 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor Present Value
2005
1
$221,468 0.949397133
$210,261.08
2006
2
$196,109 0.901354916
$176,763.81
2007
3
$162,856 0.855743773
$139,363.01
2008
4
$125,851 0.812440684
$102,246.47
2009
5
$88,680 0.771328856
$68,401.44
2010
6
$86,286 0.732297405
$63,187.01
2011
7
$86,286 0.695241056
$59,989.57
Total PV of Operating Lease Expenses:
$820,212.40
55
2005 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor Present Value
2006
1
$252,588 0.949397133
$239,806.32
2007
2
$225,649 0.901354916
$203,389.84
2008
3
$188,636 0.855743773
$161,424.08
2009
4
$150,096 0.812440684
$121,944.10
2010
5
$107,522 0.771328856
$82,934.82
2011
6
$105,660 0.732297405
$77,374.18
2012
7
$105,660 0.695241056
$73,458.82
Total PV of Operating Lease Expenses:
$960,332.16
2006 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor
2007
1
$271,811 0.949397133
2008
2
$241,454 0.901354916
2009
3
$203,066 0.855743773
2010
4
$159,912 0.812440684
2011
5
$114,104 0.771328856
2012
6
$110,617 0.732297405
2013
7
$110,617 0.695241056
Total PV of Operating Lease Expenses:
Present Value
$258,056.58
$217,635.75
$173,772.46
$129,919.01
$88,011.71
$81,004.54
$76,905.48
$1,025,306
The effect on financial ratios and financial statements will be illustrated and
explained later in the valuation.
Financial Analysis
The financial analysis is essential to forming an accurate and fair valuation
of a firm’s stock price. The financial ratios are the most important tool in the
financial analysis as they help chart a company’s performance over time on many
different benchmarks. There are three types of valuation analysis ratios:
liquidity, profitability, and capital structure that will be discussed in the following
sections.
The financial analysis also involves adjusting the financial statements for
capital lease treatment to maintain a better understanding of the firm’s true
56
assets and liabilities. In particular, retail chains are notorious for keeping these
substantial numbers off the balance sheet in the form of operating leases.
Finally the financial analysis involves extracting the proper figures to be
used in the actual valuation of the firm. The company’s cost of debt, cost of
equity, cost of capital, risk free rate, etc. are all derived in this section so that
CAPM and WACC models can be performed accurately.
Liquidity Ratios
Liquidity ratios are a great measure to help a company figure out if they
are able to pay off their current short-term debt obligations. The higher this
number is, the better for the company. There are five different ratios a company
can use to determine this: Current ratio, Quick Asset ratio, Accounts Receivable
Turnover, Days Sales Outstanding, Inventory Turnover, Days Supply of
Inventory, Working Capital Turnover, and the Cash to Cash Cycle. These ratios
are talked about more in-depth below.
Current Ratio : (current assets/current liabilities)
A company’s current ratio is determined by its current assets divided by its
current liabilities. This ratio shows whether the company is able to cover its
short-term debt obligations. It is not good if this ratio is less than one. The
higher the current ratio means the company is very liquid.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
2.07
2.80
1.37
7.74
3.50
2002
1.99
3.47
1.99
6.38
3.46
2003
1.94
2.73
2.20
4.81
2.92
2004
1.61
3.29
2.10
2.84
2.46
2005
1.51
3.19
2.14
3.13
2.50
2006
1.44
2.50
2.09
N/A
2.01
57
Over the past six years, Family Dollar’s current ratio is good. It has
always been over one. For example, in 2006, Family Dollar’s current ratio
equaled 1.44. This means that for every dollar of current liabilities, the company
has $1.44 in current assets to cover its current liabilities. If the current ratio
becomes less than one, the company does not have enough resources on hand
to cover its short-term debt. A target current ratio would be anything above
one. As long as this ratio is more than one, the company is in good shape since
it has enough current assets to cover is current liabilities (debt). This is a
concern for the banker (or loan broker) if a company’s current ratio is less than
one. Then the company will not be able to pay off their current debt with the
current assets available. No company’s listed above current ratio is less than
58
one. Family Dollar and its competitors are in good position. Family Dollar’s
current ratio over time has gradually decreased. This could be caused by our
merchandise inventories, or assets in general, being less or by the company
taking on more liabilities.
Quick Asset Ratio: (cash + securities + accounts receivables)/(current liabilities)
The Quick Asset Ratio (also known as the Acid Test) is a good tool to
determine a company’s financial strength. The formula for this ratio is cash plus
securities plus accounts receivables all divided by current liabilities. This ratio
goes deeper than the current ratio by involving all of the most liquid assets that
can be converted into cash. The higher the number means the company has
strong financial strength.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
0.06
1.18
0.23
0.13
0.40
2002
0.41
1.41
0.18
0.28
0.57
2003
0.35
0.64
0.46
0.04
0.37
2004
0.26
0.36
0.28
0.04
0.24
2005
0.16
0.22
0.25
0.08
0.18
2006
0.22
0.22
0.23
0.07
0.19
59
Family Dollar has kept a pretty consistent Quick Asset ratio. But it has
gotten smaller compared to 2002 when it was at its highest at 0.41. In 2006,
Dollar General had the best ratio out of all of the dollar stores. Dollar Tree
outperformed its competition in 2001 and 2002. Also, in 2002, the whole
industry’s quick asset ratio rose. Just as the current ratio, companies want their
quick asset ratio to be greater the one. If the quick asset ratio is one or greater,
this means that they are able to pay off their current debt with its most and
easily liquid assets. Inventory is not used in this ratio because some company’s
inventory might be slow moving. Not including inventory helps the company find
out a more real look at the company’s ability to meet its current obligations. So,
in 2006, Family Dollar had $0.22 of Quick Assets to meet $1.00 of its current
liabilities. This is a very low quick asset ratio and means that Family Dollar is
not in a good position to meet its current debt.
60
Accounts Receivable Turnover: (sales/accounts receivable)
The Accounts Receivable Turnover is the company’s sales divided by its
accounts receivables. This ratio determines how quickly the company collects its
accounts receivables.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
N/A
N/A
N/A
69.30
69.30
2002
N/A
N/A
N/A
71.04
71.04
2003
N/A
N/A
N/A
75.88
75.88
2004
N/A
N/A
N/A
95.99
95.99
2005
N/A
N/A
N/A
N/A
N/A
2006
N/A
N/A
N/A
17.47
17.47
Family Dollar has no accounts receivable, so there is no accounts
receivable turnover for the company. It is not a relevant ratio needed in this
analysis for Family Dollar. 99 Cent Only Stores is Family Dollar’s only competitor
that has accounts receivable therefore it is the only one with an Accounts
61
Receivable Turnover. 99 Cent Only Store’s accounts receivable turnover in 2006
was 320.573. This means for every dollar of accounts receivable, the company
has $320.57 in sales to cover its accounts receivables.
Day Sales Outstanding: (365/ Accounts Receivable Turnover)
The Days Sales Outstanding equals 365 (the number of days in a year)
divided by the accounts receivable turnover. This ratio tells you how long it
takes a company to collect revenue after a sale has been made. The lower this
ratio is the better.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001 2002
N/A
N/A
N/A
N/A
N/A
N/A
164.14 259.33
164.14 259.33
2003
N/A
N/A
N/A
384.17
384.17
2004
N/A
N/A
N/A
280.73
280.73
2005
N/A
N/A
N/A
N/A
N/A
2006
N/A
N/A
N/A
320.57
320.57
62
Once again, Family Dollar does not have a Days Sales Outstanding ratio
since the company has no accounts receivable on its books. 99 Cent Only Stores
is the only competitor with this ratio. In 2001, it takes 99 Cent Only Stores 2.2
days to collect its accounts receivables from its customers. This ratio is also
used in the Cash to Cash Cycle (or the Money-Go-Round) ratio.
Inventory Turnover: (cogs/inventory)
Inventory Turnover is determined by taking the company’s cost of goods
sold divided by its inventory. This ratio tells us how many times a company’s
inventory is sold and then replaced over a specific period of time.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
3.38
4.29
3.37
5.27
4.08
2002
3.61
4.14
3.90
5.14
4.20
2003
3.68
3.39
4.19
4.81
4.02
2004
3.57
3.27
3.92
3.80
3.64
2005
3.58
3.85
4.15
N/A
3.86
2006
4.12
4.32
4.75
N/A
4.40
63
In 2006, Family Dollar’s inventory turnover was 4.12. This means it took
4.12 times for Family Dollar to sell its inventory and then replace it with new
inventory. 99 Cent Only Stores had the worst inventory turnover by far in 2006.
It took 20.89 times to replace its inventory once it was sold for this company.
The industry pretty much kept steady in line with each other. If the inventory
turnover is low, this could mean poor sales and an excess amount of inventory
for the company. But if this ratio is high, it could be because of a lot of sales
that the company is making. A high inventory turnover is a good implication of
positive operating efficiency of the company, but this could not always be the
case. This is why we need to look at Family Dollar’s competitors and get the
industry average to compare to see if the inventory turnover ratio for Family
Dollar is good or not. The past three years, Family Dollar’s inventory turnover
has been close to the industry average.
64
Days Supply of Inventory: (365/Inventory Turnover)
Days Supply of Inventory is the inventory turnover divided into 365. Also
known as Days Inventory Outstanding (DIO), this measure will give an investor a
figure of the number of days it takes for a firm to convert inventories into sales.
A lower (shorter) Days Supply of Inventory indicates a firm operating more
efficiently as versus a higher DIO figure. DIO is added to day’s sales outstanding
to compute a cash conversion cycle figure.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
107.97
85.119
108.25
69.30
92.66
2002
101.14
88.135
93.67
71.04
88.50
2003
99.13
107.7
87.01
75.88
92.43
2004
102.32
111.57
93.08
95.99
100.74
2005
101.86
94.726
87.97
2006
88.58
84.536
76.86
94.85
83.33
65
Family Dollar’s Days Supply of Inventory stayed relatively the same from
2001 through 2006. Year 2006 was Family Dollar’s best DIO figure with 88.58
days for them to convert inventories into sales. In 2004, Dollar Tree had the
worst Days Supply of Inventory which was 111.57 days. There was no
information available for 99 Cent Only Stores in 2005 and 2006. This is why
there is no DIO figure for these years. In the last year that 10K’s were available,
in 2006, Dollar General by far had the best Days Inventory Outstanding out of
the four companies. Dollar General had a 76.86 days supply of inventory.
Family Dollar had the worst in the industry this year of 88.58 days, but this was
there best figure out of the six years. Overall, the discount variety store industry
kept about the same with each other over the past six years.
Working capital turnover: (Sales/Working Capital)
Sales divided by the difference of current assets minus current liabilities
will yield the working capital turnover. “The working capital turnover ratio is
used to analyze the relationship between the money used to fund operations and
the sales generated from these operations” (investopedia.com). The higher the
turnover the better because that means a firm is producing a high number of
sells relative to a low amount of working capital (money).
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
2002
2003
2004
2005
2006
8.79
7.93
8.46
10.79
12.66
14.78
5.51
4.57
6.12
4.63
5.24
6.89
12.60
9.25
7.61
8.46
9.28
10.08
2.98
3.46
3.96
5.26
7.47
6.30
6.54
7.28
9.06
10.58
66
Again, there was no available information for 99 Cent Only Stores in 2005
and 2006. Their worst working capital turnover was 2.98 in 2001. But it is
slowly getting bigger which is good. Over the past six years, Family Dollar’s best
Working Capital Turnover was in 2006 with a turnover of 14.78. This is the best
turnover of all of the companies from 2001 to 2006. The industry’s average
keeps getting better year after year.
Cash to Cash Cycle: (Days Sales Outstanding + Days Supply of Inventory)
The Cash to Cash Cycle, also referred to as the Money-Go-Round, is
determined by taking the Days Sales Outstanding plus the Days Supply of
Inventory. This formula measures how long it takes to receive accounts
receivable and how long to convert inventory into sales. It is bad for the
company when this number increases. “The higher the number, the longer a
firm’s money is tied up in the business operations and unavailable for other
activities such as investing” (Wikipedia.com). This is an important measure for
any business.
67
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001 2002
107.97 101.14
85.12
88.13
108.25
93.67
71.52
72.45
93.22
88.85
2003
99.13
107.70
87.01
76.83
92.67
2004
102.32
111.57
93.08
97.29
101.07
2005
101.86
94.73
87.97
N/A
94.85
2006
88.58
84.54
76.86
18.61
67.15
The only company in the four above that takes into account the days sales
outstanding and the days supply of inventory is 99 Cent Only Stores. The other
three companies, Dollar General, Dollar Tree, and Family Dollar, do not have a
Days Sales Outstanding. So their Cash to Cash Cycle only takes into account the
Days Supply of Inventory. Family Dollar’s Cash to Cash Cycle stayed relatively
the same from 2001 to 2005. In 2006, the Cash to Cash Cycle for FDO went
down to 88.58 days which is better than the previous years. Over the past six
years, Dollar Tree had the worst Cash to Cash Cycle in 2004 with a cycle of
111.57 days. The industry average was the best in 2006 with an average Cash to
Cash Cycle of 67.15 days.
68
Overall Liquidity Ratios Conclusion
Again, the liquidity ratios help a company determine whether or not they
can pay off their short-term debt obligations. The higher the ratio is gives the
company a higher margin of safety. Family Dollar does not seem to be a fairly
liquid company. Two of the most important ratio, Current Ratio and Quick Asset
Ratio, illustrated Family Dollar’s poor performance. The firm was not even to
beat the industry average in most years. It would make investors more confident
and secure if Family Dollar was able to pay its current debts off more easily.
Family Dollar did not perform well on the remaining liquidity ratios as well.
Overall, our assessment of Family Dollar’s liquidity is that they are poorly to
averagely liquid.
Profitability Ratios
Profitability ratios are used to assess a company’s ability to generate
revenue taking into consideration their incurred costs of everyday operations. A
higher ratio compared to another company is a usually a favorable measure.
These ratios are the Gross Profit Margin, the Operating Profit Margin, the Net
Profit Margin, the Asset Turnover, Return on Assets, and Return on Equity.
These Profitability ratios are discussed more below.
Gross Profit Margin: (Gross Profit/Sales)
Gross profit is figured by subtracting the cost of goods sold from sales
(revenue). The gross profit margin ratio is figured by dividing sales into gross
profit. The higher the gross profit margin the more efficient a company is
operating. Gross margin represents the amount of money left over for saving or
paying other expenses after paying for the costs of sales. If a gross profit margin
69
is equal to 30%, a company will have $0.30 left over for every one dollar of
sales. Gross profit margin is the most basic measure of product profitability.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
33.45%
36.03%
28.36%
48.05%
36.47%
2002
2003
2004
2005
2006
33.53% 33.78% 33.81% 32.90% 33.13%
36.41% 36.37% 35.59% 34.54% 34.19%
28.26% 29.37% 29.54% 28.72% 25.83%
40.14% 40.09% 39.05%
N/A
37.46%
34.59% 34.90% 34.50% 32.05% 32.65%
Family Dollar’s gross profit margin stayed pretty stable over the last six
years at around 33%. 99 Cent Only Stores had the best gross profit margin in
2001 with a margin of 48.05%.
companies from 2001 to 2006.
This was also the best out of all of the
Again, there was no available information in
2005 for 99 Cent Only. The lowest gross profit margin out of the past six years
was 25.83%, which was Dollar General. This means they are only earning $0.26
70
for every dollar of sales. Dollar General’s gross profit margin stayed in the 28%
area. Overall, the industry average stayed around 34% over the past six years.
Operating Profit Margin: (Operating Income/Sales)
Operating profit margin is similar to Gross profit margin in the sense that
it “is used to measure a company’s pricing strategy and operating efficiency”
(investopedia.com). By dividing income from operations by sales, a percentage
will be generated that will indicate the amount of every dollar of sales that is left
over before interest and taxes. Again the higher the percentage the more
efficient a firm is operating. Comparing the change in margin over past years of
operations for a firm is a great way for analysts to determine the healthiness of a
company.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
Family Dollar
(revised)
2001
2002
2003
2004
2005
2006
8.14%
8.21%
8.20%
7.70%
5.89%
4.87%
10.00% 11.00% 10.00%
9.00%
8.00%
8.00%
20.50% 28.40% 21.30% 21.80% 22.30% 22.20%
48.05% 40.14% 40.09% 39.05%
37.46%
21.67% 21.94% 19.90% 19.39% 12.06% 18.13%
8.84%
8.95%
8.97%
8.46%
6.70%
5.82%
71
Family Dollar’s operating profit margin went from 8.14% in 2001 down to
4.87% in 2006.
This margin is getting smaller for Family Dollar and it’s the
smallest for the whole industry. 99 Cent Only Stores has the highest operating
profit margin by far over the past six years. The highest was in 2001 with a
margin of 48.05%. There was no available information for 99 Cent Only Stores
in 2005. The industry average for these companies stayed around 20% give or
take. The revised series was necessary because the capital lease adjustments
increased operating income, resulting in a slightly higher margin.
Net Profit Margin: (Net Income/Sales)
Net Income divided by sales, which is the Net Profit Margin, is a ratio that
will indicate the percent of a dollar of sales that a firm keeps as earnings. An
increase in net income from year to year might look good but can be misleading
if the actual percentage of net income to sales is decreasing. A decrease over
the years signals a lowering level of operating efficiency. The net profit margin
is an excellent ratio to use to compare firms in industries of similar nature.
72
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001 2002
2003
2004
2005
2006
5.17%
5.21%
5.21%
4.88%
3.73%
3.05%
6.00%
7.00%
6.00%
6.00%
5.00%
5.00%
3.90%
9.25%
4.35%
4.49%
4.08%
1.50%
8.38%
8.51%
6.81%
2.86%
N/A
1.12%
5.86%
7.49%
5.59%
4.56%
4.27%
2.67%
There was an increase from 2003 to 2006 for Family Dollar’s Net Profit
Margin. It went from 5.21% down to 3.05%. Dollar Tree’s margin stayed at
around 6.0% over the years. The lowest net profit margin was for 99 Cent Only
Stores in 2006.
This margin was 1.12%. 99 Cent Only Stores also had the
highest net profit margin out of these four companies with a margin of 8.51%.
The industry average went from 7.49% in 2002 down to 2.67% in 2006. This
industry doesn’t have a good level of operating efficiency in 2006 compared to
2002.
73
Asset Turnover: (Sales / Total Assets)
The asset turnover can be found by dividing total sales by total assets.
This calculation measures the sales of the company in relation to the total assets
a company has acquired. This illustrates the companies level of efficiency in
using their assets to create sales. The higher this number is the better it is for
the company and the more efficient and effective they are.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
Family Dollar (revised)
2001 2002
2003
2004
2005
2006
2.62
2.37
2.39
2.37
2.42
2.53
2.20
2.09
1.89
1.74
1.89
2.12
1.99
2.09
2.62
2.16
2.70
2.88
1.64
1.62
1.56
1.62
1.63
2.11
2.04
2.11
1.97
2.33
2.29
1.95
1.78
1.78
1.73
1.73
1.80
The Family Dollars asset turnover ratio was 2.53 in 2006. This means that
for every dollar worth of assets the company is making 2.53 dollars in sales. In
the past six years the number has dropped from 2.62 in 2001. At the lowest
74
point in six years the ratio dropped to 2.37 in 2002 and 2004. It has since
started to increase slowly. The drop over time is not too significant but, is still
important to point out. The increase in the last few years is a good sign that the
company is making strides to improve. Even with the decrease, The Family Dollar
is still ahead of all of its competitors except for The Dollar General, which
boasted a 3.0 asset turnover in 2006 to top off a steady growth from 1.99 in
2001. Even with the decrease, the Family Dollar is still one of the top companies
in respect of asset turnover, but the clear leader is The Dollar General. The
Family Dollar revision resulted in a lower margin because total assets increased
tremendously while sales stayed constant
Return on Assets: (Net Income/Total Assets)
The return on assets can be calculated by dividing the net income by the
total assets of the company. The previous year’s assets are used in the
calculation with the current year’s net income because the purpose is to measure
the effect of the assets the company has invested in. the higher this number is
the better. This tells investors that the company is using assets to make a profit.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
Family Dollar
(revised)
2001
2003
0.14
0.12
0.11
0.13
0.13
2004
0.13
0.10
0.11
0.05
0.10
2005
0.10
0.10
0.12
0.09
2002
0.15
0.14
0.08
0.17
0.14
0.11
2006
0.08
0.10
0.12
0.02
0.08
0.10
0.09
0.09
0.08
0.06
0.05
0.14
0.03
75
The Family Dollar’s ROA has decreased steadily over the past six years
from 15.5% in 2002 to 8.10% in 2006. This is a significant decrease and could
raise eyebrows of investors. This shows that even though the sales have
increased the net income has decreased when compared to assets. When
compared to its competitors, The Family Dollar comes in third to the Dollar Tree
which had an ROA of 8.10% in 2006 and Dollar General which boasted an 11.7%
return. As an overall look all of the competitors’ ROAs took a fall from 05 to 06
so something obviously went on within the industry to cause this, so this can’t be
considered to be an equally important year. In the conclusion, Family Dollar’s
ROA has decreased and is cause for some concern. It has been in a steady
declination since 2001, and it coming very close to not meeting the industry
standards. FDO’s upper level management is not doing as good of a job as it
competitors in producing income from the assets the firm has acquired. Similarly
to Asset Turnover, the revised ROA is lower than the original because total
assets increased and net income did not.
76
Return on Equity: (Net Income/ Equity)
The Return on Equity (ROE) can be calculated by dividing net income by
equity. The return on equity is one of the most important ratios for an investor to
look at because it measures how well the management is putting to use the
money the investors have invested in the company. “Large publicly traded firms
in the U.S. generate ROEs in the range of 11 to 13 percent.”(Business Analysis
and Evaluation, Palepu & Healy.) Like the Return on Assets ratio, when
computing the ratio it is important to note that the equity from the previous year
should be used with the current year’s net income, as to see the effect of the
investments in equity of from the year before.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
Family Dollar
(revised)
2001
0.19
0.08
0.14
2002
0.15
0.18
0.20
0.19
0.18
2003
0.14
0.18
0.21
0.15
0.17
2004
0.13
0.15
0.19
0.06
0.13
2005
0.10
0.15
0.20
0.15
2006
0.08
0.16
0.20
0.02
0.12
0.15
0.14
0.13
0.10
0.08
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The Family Dollar’s ROA decreased from 22.6% in 2002 to 13.66% in
2006 which is a significant difference. Except for Dollar General the rest of the
competitors saw similar decreases. Even with the decrease, The Family Dollars
Return on Equity is still above the U.S. average which is stated before to be
13%. This could mean that the high ratios in the earlier years could be abnormal
when compared to the overall expected ratios for the industry brought forth by
an unusual trend in this time period.
The firms ROE percentage decreasing
steadily is the main thing that is alarming but, most of the industry have
experienced the same trend. The actual ROE for 2006 is just at the industry
average, which according to the particular investor could be acceptable or not. In
conclusion, the firm could do a better job implementing the capital raised
through shareholder investing, to ensure the shareholders are satisfied and to
create value for the firm. The Capital lease restructuring did not affect ROE.
78
Profitability Ratios Conclusion
From all of the ratios listed above in this section, one can tell if a company
is doing well or not. These profitability ratios are a great tool for companies to
use to determine how much profit a company is earning after taking into account
their expenses of operating. Looking at the ratios above, FDO has not been as
successful as the other companies in regards to increasing ratio percentages.
FDO had consecutive decreases across the board in all ratios except for Asset
Turnover and Gross Profit Margin. When compared to the rest of the industry
and FDO’s competitors, this is a poor performance. With this being said, even
with the decreasing ratio percentages, FDO still beat the industry average in
every profitability ratio except Operating Profit Margin. The Family Dollar, even
though beating industry average, is performing poorly in context to profitability
ratios when compared to its competitors. The firm could do a better job in
investing in assets that will produce more income and use the shareholders’
investments to do the same. FDO could also improve on their operating
efficiency and pricing strategy, to more closely resemble its competitor’s ratios.
Overall, FDO is mediocre in comparison to its competitors and industry which
should be made note of by investors.
Capital Structure Ratios
The following ratios and diagnostics help assess the degree to which a
company is financed by debt and equity. One of the most important pieces of
the information that can be pulled from these ratios is how much leverage, or
the ratio of debt to total financing (Wikipedia.com), that the firm possesses.
There are several ratios and growth rates that help ascertain a better
understanding of a firm’s capital structure: debt to equity ratio, times interest
earned, and the debt service margin.
79
Debt to Equity: (Total Liabilities/ Owners’ Equity)
The debt to equity can be found by dividing total liability by total equity.
This ratio shows how much debt the firm is using to finance its assets. The lower
the ratio the better it is because it means that the company is keeping debt low.
While it is necessary for firms to borrow money to increase in profitability, it is
important not to over stretch. A firm should try to aim for a ratio fewer than 2.0.
This ratio is not only important to investors, but also banks. When money is
borrowed from a bank, often times the bank will set the limits in which the debt
to equity ratio cannot go above. If the ratio creeps above the specified limit, it
could prompt penalization of the firm on the bank’s terms.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
2002
2003
2004
2005
2006
0.46
0.52
0.51
0.66
0.69
1.09
0.38
0.31
0.46
0.54
0.53
0.60
1.65
1.45
0.81
0.87
0.87
0.73
0.10
0.11
0.13
0.23
0.20
0.25
0.65
0.60
0.48
0.57
0.57
0.67
80
The Family Dollar has increased its debt to equity ratio from .46 in 2001
to 1.09 in 2006. This is a pretty big jump up, but is still under 2.0. This could be
taken as a good thing because sales have increased over the last six years which
could be a result of debt financing growth. Compared to its competitors the
Family Dollar is borrowing about the same as the other companies even with a
slightly higher ratio in 2006. This should be nothing for investors or banks to be
worried about.
Times Interest Earned: (NIBIT/Interest Expense)
The times interest earned can be found by dividing the net income before
interest and tax by interest expense. This ratio is vital in knowing if the firm can
pay the interest charge from the borrowed money. The higher the ratio is the
better. This indicates that the firm has enough to pay for its debt.
81
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001 2002 2003 2004 2005 2006
N/A
N/A
N/A
N/A
N/A
23.76
0.32
0.33 -38.54 -31.18 -19.60 -18.36
2.40
7.20
9.72
13.38
18.57
20.77
N/A
N/A
N/A
N/A
N/A
N/A
1.36
3.76 -14.41
-8.90
-0.51
1.20
The Family Dollar did not have any data for the years leading up to 2006
but, did have a TIE ratio of 23.76 in 06. This is second to 99 Cent Store’s ratio of
25.36. Compared to the rest of the firms FDO is not doing badly in this area. The
Dollar Tree seems to be hurting the most with a ratio of negative 18.36. The
Family Dollars ability to pay their debts is favorable.
82
Debt Service Margin: (CFFO/Current Notes Payable)
The Debt Service Margin is found by taking the cash flows from operating
activities of the current year divided by the notes payable of the previous year.
It determines a company’s ability to pay its required payment of current debt.
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
N/A
N/A
23.85
N/A
23.85
2002
N/A
8.28
0.67
N/A
4.47
2003
N/A
9.75
26.78
N/A
18.26
2004
N/A
11.06
30.84
N/A
20.95
2005
N/A
19.22
30.44
N/A
24.83
2006
N/A
14.55
63.23
N/A
38.89
Dollar General has the highest margin meaning it has the best ability to
pay its installments on debt. Family Dollar and 99 Cents Only Store do not have
83
any notes payable on their balance sheets and were left out of this comparison
analysis. Dollar Tree has an adequate debt service margin and should not have
any problems covering their debt.
Overall Capital Structure Ratios Conclusion
The capital structure analysis shows that for the most part Family Dollar in
operating on a solid capital structure foundation. FDO’s debt to equity ratio was
comparable to those in the industry except for the spike in 2006. This spike is
due to liabilities from increased debt financing in order to foster company
growth. It is still well below 2.0 and is no cause for alarm. The times interest
earned for FDO was unavailable for all years except 2006 as there was no
interest expense recognized. The 23.76 TIE for 2006 is; however, the second
highest in the industry and a very good sign for lending institutions. Debt
service margin was unavailable for FDO, but only because they do not have any
notes payable on the balance sheet which is inherently positive. As long as
Family Dollar does not deviate from their current business strategy, their capital
structure will remain strong.
IGR/SGR Analysis
Internal Growth Rate: (ROA (1-Dividend %))
The Internal Growth Rate (IGR) is found by taking the company’s Return
on Assets multiplied by one minus the dividend percentage. The dividend
percentage is the company’s annual dividends divided by its net income. The
IGR is a measure of how much a company can grow its assets without using any
outside financing. The greater the IGR the more a company is financing projects
with retained earnings. Family Dollar’s IGR has declined over the past five years;
however, this decline is inline with the rest of its competitors.
84
Company
Family Dollar
Dollar Tree
Dollar General
99 Cent Only
Industry Average
2001
N/A
N/A
N/A
N/A
N/A
2002
15.50%
11.03%
22.11%
17.25%
16.47%
2003
14.10%
10.45%
12.82%
13.34%
12.68%
2004
12.99%
9.91%
13.13%
5.03%
10.26%
2005
2006
9.78% 8.10%
10.02% 9.28%
12.33% 4.63%
N/A
1.94%
10.71% 5.99%
The decline is, in all probability, due to the industry’s need to grow in
order to stay competitive. The industry, as previously stated, is highly
concentrated, thus the only way to gain market share is aggressive acquisitions.
To fund these large purchases all firms in the industry must seek outside
financing or lose market share. As long as FDO’s IGR decline stays above or
inline with its competitors this decline should not turn off investors.
85
Sustainable Growth Rate: IGR (1+ (Total Debt/Total Equity))
This ratio uses the debt to equity ratio in its formula along with the
Internal Growth Rate. The Sustainable Growth Rate (SGR) is a growth rate that
is found by taking the company’s Internal Growth Rate times one plus the total
debt divided by the total equity. Investopedia.com states that this rate “is the
maximum growth rate that a firm can sustain without having to increase financial
leverage.” This rate tells you how much a firm can grow without putting on
more debt for the company.
Company
2001
2002
2003
2004
2005
2006
Family Dollar
N/A
23.54%
21.36%
21.61%
16.50%
16.91%
Dollar Tree
N/A
14.39%
15.24%
15.25%
15.38%
14.89%
Dollar General
22.28%
40.05%
21.61%
22.15%
21.35%
8.06%
99 Cent Only
N/A
19.13%
15.07%
6.18%
N/A
2.43%
22.28%
24.28%
18.32%
16.30%
17.74%
10.57%
Industry Average
86
Family Dollar’s sustainable growth rate has slowly gotten smaller, which is
not good. In 2002, FDO’s sustainable growth rate was 23.54%. This rate fell to
16.91% in 2006. Family Dollar is only able to grow so much now before having
to borrow funds to keep operating. 99 Cent Only Stores had the worst
sustainable growth rate out of its competitors. In 2006, 99 Cent Only Stores had
a SGR of only 2.43%. This is very low. The industry average went up and down
over the past six years. The best industry average was in 2002 with an average
of 24.28%. This rate has slowly gone down to a 10.57% sustainable growth
rate.
Financial Statement Analysis
Financial Statement Forecasting
When performing a fundamental analysis, forecasting income statements,
balance sheets, and statements of cash flows is an essential key in determining
the intrinsic value of a security. Forecasting future trends of an industry or firm
focuses on analyzing current and past data that can be gathered from sources
such as 10’K reports.
We forecasted future trends of Family Dollar Inc.’s financial statements for
the next ten years dating to 2016. Our analysis was based on the most recent
six years of FDO’s activity dating back to 2001. When computing our forecasts’,
we also analyzed Dollar Tree’s, Dollar General’s, and 99 Cent Only Store’s
financial data for the same period. In doing so, we were able to make
assumptions by recognizing and comparing trends across the industry to FDO.
87
Income Statement
Actual Financial Statements
(in thousands)
2001
2002
2003
2004
2005
Forecast Financial Statements
2006 Assume 2007 2008 2009
2010
2011
2012
2013
2014
2015
2016
Years ended
Net sales
Cost of sales
2001 31-Aug-02 30-Aug-03 28-Aug-04 27-Aug-05 26-Aug-06
$3,665,362 $4,162,652 $4,750,171 $5,281,888 $5,824,808 $6,394,772 10.42% $7,061,107 $7,796,875 $8,609,309 $9,506,399 $10,496,966 $11,590,750 $12,798,506 $14,132,110 $15,604,676 $17,230,683
$2,439,261 $2,766,733 $3,145,788 $3,496,278 $3,908,569 $4,276,466 66.57% $4,700,579 $5,190,379 $5,731,217 $6,328,410 $6,987,830 $7,715,962 $8,519,965 $9,407,746 $10,388,033 $11,470,466
Gross Profit
$1,226,101 $1,395,919 $1,604,383 $1,785,610 $1,916,239 $2,118,306
$2,360,528 $2,606,495 $2,878,092 $3,177,989 $3,509,136 $3,874,788 $4,278,540 $4,724,364 $5,216,643 $5,760,217
Selling, general and administrative
$927,679 $1,054,298 $1,214,658 $1,382,248 $1,577,429 $1,756,001 25.89% $1,828,121 $2,018,611 $2,228,950 $2,461,207 $2,717,664 $3,000,845 $3,313,533 $3,658,803 $4,040,051 $4,461,024
Litigation charge (Note 8)
$0
$0
$0
$0
$0 $45,000
$6,528,700 $7,208,990 $7,960,167 $8,789,616 $9,705,495 $10,716,807 $11,833,498 $13,066,549 $14,428,083 $15,931,490
Cost of sales and operating expenses $3,366,940 $3,821,031 $4,360,446 $4,878,526 $5,485,998 $6,077,467
Operating profit
$298,422 $341,621 $389,725 $403,362 $338,810 $317,305 7.54% $532,407 $587,884 $649,142 $716,782 $791,471 $873,943 $965,007 $1,065,561 $1,176,593 $1,299,193
Interest income
Interest expense
$0
$0
$0
$0
$0
$0
$3,300
$0
$3,985
$0
$6,934
$13,095
Income before income taxes
$298,422 $341,621 $389,725 $406,662 $342,795 $311,144
Income taxes
$108,917
Net income
$189,505 $216,929 $247,475 $257,904 $217,509 $195,111 4.54% $320,574 $353,978 $390,863 $431,591
$124,692
$142,250 $148,758
$125,286 $116,033
$476,562
$526,220
$581,052
$641,598
$708,452
Forecasting out the income statement was our first step in the process.
We started by evaluating the first line item in the income statement, net sales.
We noticed that the sales growth percentage from year to year was fairly
consistent. The average sales growth percentage rate from 2001 to 2006
equaled 11.79%. We chose to assume that sales would grow at a slightly less
rate of 10.42% for the next ten years. We were conservative with our
assumption in order to factor in a slowing economy. Also, observing that Yahoo!
Finance predicted a 5-year future sales growth rate of 10.96% influenced our
assumed future growth rate.
Next, we forecasted FDO’s cost of sales. Cost of sales has consistently
accounted for an average of 66.57% of sales for the past 6 years. Thus we
chose to assume that this will hold true for years to come. Gross profit was then
88
$782,273
forecasted as the difference of sales and cost of sales. Gross profit averaged
33.43% in the past which also gave reason for our previous assumptions.
Like cost of sales, the common size income statement revealed that
selling, general, and administrative expenses, accounted for 25.89% of sales on
average with little variance from ’01 to ’05. In the year 2006 there was an
increase in S,G,&A in comparison to previous years. After reading FDO’s 2006
10-K, we learned that it was a onetime litigation charge from a court ruling
against FDO. Being that, we chose to leave fiscal year 2006 out of the average.
Our assumed rate for the S,G,&A forecast was that of the average because of
the consistency across the common size income statement.
Net income was forecasted under the same circumstances. The average,
4.58% of sales, from the common size statement for the periods of 01-05 was
used to forecast the net income. We chose to assume that this rate would hold
true because the FDO 10k spoke of offsetting certain expenses with the
continuing growth of sales. For example, the 2007 10-K stated that FDO would
continue to open new distribution centers to more efficiently deliver freight due
to higher fuel costs. Our assumption rate for forecasting out operating profit
was also derived from the average percent (7.54%) of total sales that it
represented on the common size income statement. We also viewed the
forecasted statement in a similar way as common size income statement to
check for errors.
We reassured the credibility of all our forecasted values by applying
simple accounting rules to confirm that our numbers added up.
Income Statement (Revised):
Because we treated the operating leases as financing expenses, Operating
Income increased by the reversal of the Operating Lease Rent that is reported by
Family Dollar in each year. The expense is usually not a line item listed and is
therefore embedded into COGS or SGA expenses. Also, assuming capitalizing the
operating leases, an estimated interest and depreciation expense can be derived
89
by using given long-term rate of borrowing (the same to calculate the PV of all
future operating leases). This Inputed interest expense is subtracted from gross
profit. Operating Income will still be higher than using the original operating
lease method.
Net Income stays the same because operating lease expenses will be equal to
the sum of all the imputed interest expense and the depreciation of the
capitalized lease. These are the assumptions we believed to be most accurate in
our revised Income Statement.
90
Balance Sheet
2001
(in thousands, except per share and share
amounts)
Assets
Current assets:
Cash and cash equivalents
Investment securities (Note 2)
Merchandise inventories
Deferred income taxes (Note 6)
Income tax refund receivable
Prepayments and other current assets
Total current assets
Actual Financial Statements
2002
2003
2004
2005
2006
Assume
2007
Forecast Financial Statements
2008
2009
2010
2011
2012
2013
2014
2015
2016
$21,753
$0
$721,560
$43,985
$4,936
$15,031
$807,265
$220,265
$0
$766,631
$49,941
$6,469
$12,553
$1,055,859
$206,731
$0
$854,370
$61,769
$0
$33,622
$1,156,492
$87,023
$120,840
$980,124
$84,084
$1,304
$16,937
$1,290,312
$105,175
$33,530
$1,090,791
$100,493
$0
$24,779
$1,354,768
$79,727
$136,505
$1,037,859
3.76
$133,468
$2,397
$28,892
$1,418,848 57.76%
$1,250,154
$1,380,420
$1,524,260
$1,683,088
$1,858,465
$2,052,118
$2,265,948
$2,502,060
$2,762,775
$3,050,656
$1,664,692
$1,838,153
$2,029,689
$2,241,182
$2,474,713
$2,732,578
$3,017,313
$3,331,717
$3,678,882
$4,062,221
$580,879
$11,601
$592,480
$685,617
$13,143
$698,760
$812,123
$17,080
$829,203
$918,449
$15,600
$934,049
$1,027,475
$27,258
$1,054,733
$1,077,608 41.35%
$26,573
$1,104,181 42.24%
$1,191,742
$25,651
$1,217,393
$1,315,921
$28,323
$1,344,245
$1,453,041
$31,275
$1,484,315
$1,604,447
$34,533
$1,638,981
$1,771,631
$38,132
$1,809,763
$1,956,235
$42,105
$1,998,340
$2,160,074
$46,493
$2,206,567
$2,385,154
$51,337
$2,436,491
$2,633,687
$56,686
$2,690,373
$2,908,117
$62,593
$2,970,710
$1,399,745
$1,754,619
$1,985,695
$2,224,361
$2,409,501
$2,523,029
2.45
$2,882,085
$3,182,398
$3,514,004
$3,880,163
$4,284,476
$4,730,918
$5,223,880
$5,768,208
$6,369,255
$7,032,932
$264,965
$12,329
$0
$390,294
$0
$50,436
$381,164
$149,616
$0
$530,780
$0
$68,891
$401,799
$192,861
$671
$595,331
$0
$79,395
$534,405
$266,180
$0
$800,585
$0
$86,694
$574,831
$315,508
$4,272
$894,611
$0
$86,824
$556,531
$429,580
$0
$986,111
$250,000
$78,525
26%
$749,342
$827,423
$913,641
$1,008,842
$1,113,964
$1,230,039
$1,358,209
$1,499,734
$1,656,006
$1,828,562
$50,436
$68,891
$79,395
$86,694
$86,824
$328,525
$680,705
$633,905
$582,228
$525,167
$462,159
$392,586
$315,764
$230,937
$137,271
$33,845
$440,730
$599,671
$674,726
$887,279
$981,435
$1,314,636
$1,430,047
$1,461,328
$1,495,869
$1,534,009
$1,576,123
$1,622,625
$1,673,973
$1,730,671
$1,793,277
$1,862,407
Common stock, $.10 par; authorized
600,000,000 shares; issued 178,559,411
shares at August 26, 2006, and 188,871,738
shares at August 27, 2005, and outstanding
150,210,484 shares at August 26, 2006, and
165, 262,513 shares at August 27, 2005
Capital in excess of par
Retained earnings
Total
$18,454
$40,318
$945,192
$1,003,964
$18,583
$63,294
$1,118,015
$1,199,892
$18,691
$87,457
$1,315,600
$1,421,748
18,767
106,853
1,498,890
$1,624,510
$18,887
$133,743
$1,654,861
$1,807,491
$17,856
$140,829
$1,546,366
$1,705,051
$1,790,010
$2,059,042
$2,356,108
$2,684,127
$3,046,326
$3,446,266
$3,887,880
$4,375,510
$4,913,951
$5,508,498
Less: common stock held in treasury, at cost
(28,348,927 shares at August 26, 2006, and
23,609,225 shares at August 27, 2005
Total shareholders equity
$44,949
$959,015
$44,944
$1,154,948
$110,779
$1,310,969
287,428
$1,337,082
$379,425
$1,428,066
$496,658
$1,208,393
$1,452,037
$1,721,069
$2,018,135
$2,346,154
$2,708,353
$3,108,293
$3,549,907
$4,037,537
$4,575,978
$5,170,525
Total Liabilities and Shareholders Equity
$1,399,745
$1,754,619
$1,985,695
$2,224,361
$2,409,501
$2,523,029
$2,882,085
$3,182,398
$3,514,004
$3,880,163
$4,284,476
$4,730,918
$5,223,880
$5,768,208
$6,369,255
$7,032,932
Property and equipment, net (Note 3)
Other assets
Non-Current Assets
Total Assets
Liabilities and Shareholders Equity
Current liabilities:
Accounts payable
Accrued liabilities (Note 5)
Income taxes payable
Total current liabilities
Long-term debt (Note 4)
Deferred income taxes (Note 6)
Non-Current Liabilities (forecast plug)
TOTAL LIABILITIES Forecast plug
Shareholders equity: (Notes 9, 10 and 11)
Preferred stock, $1 par; authorized and
unissued 500,000 shares
To forecast the FDO balance sheet we began by looking at the profitability
ratio, asset turnover. The average asset turnover ratio for FDO for the past six
years is 2.45. We assessed the average asset turnover ratio for FDO’s
competitors to make an assumption. We noticed that Family Dollar and Dollar
General continually produced a higher asset turnover ratio in comparison to
Dollar Tree and 99 Cent Only. Because of the similar movements in the asset
turnover ratio for FDO and Dollar General, we assumed that the FDO 2.45
average ratio is a feasible ratio to assume for forecasting total assets. We
91
divided our forecasted sales from the income statement by 2.45 in order to
compute total assets.
From forecasting total assets we headed to merchandise inventories
because of the pattern in the common size balance sheet. The 2001 to 2006
average inventory turnover ratio was used to compute and forecast inventories.
By dividing the forecasted cost of sales by the FDO inventory turnover average
3.76, we were able to forecast merchandise inventories out to 2016. We
assumed that 3.76 was the best ratio to use because it was lower than the
industry average and FDO’s inventory turnover ratio has been below the industry
average for the past six years.
The common size balance sheet revealed to us that current assets have
accounted for, close to, 57.76% of total assets. Being that, thus, we assumed
that rate to forecast out current assets.
Property and equipment were
forecasted out using an assumed rate of 41.35% of noncurrent assets. This rate
was derived from analyzing the obvious trend in the common size balance sheet.
Using the principles of balancing our balance sheet we were able to forecast out
the total noncurrent assets as well as the line item, other assets.
Retained earnings, shareholders’ equity and liabilities were the last items
to forecast. Retained earnings for each year were calculated by adding net
income to the beginning balance of retained earnings (previous year) and
subtracting out dividends. Shareholder’s equity for year t was forecasted using
the same principal: S.E.t=S.E.t-1 + N.I.t – Div.t. We used simple math to forecast
out total liabilities remembering that assets are equal to the sum of liabilities and
shareholders’ equity. Current liabilities were calculated as an assumed
percentage of total liabilities and equity rather than using the current ratio.
Adding and subtracting line items was the final process in filling in the blanks.
Balance Sheet (Revised):
Based on the simple assumption that all future operating lease expenses can be
discounted back using an accurate PV factor to produce a capital lease, there will
92
only be a small adjustment needed on the Balance Sheet. The PV of all future
operating lease payments will create a single value that will be added to the
long-term liabilities section and the long-term assets section.
93
Statement of Cash Flows
2001
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization
Deferred income taxes
Stock-based compensation expense, including
tax benefits
Loss on disposition of property and equipment
Changes in operating assets and liabilities:
Merchandise inventories
Income tax refund receivable
Prepayments and other current assets
Other assets
Accounts payable and accrued liabilities
Income taxes payable
CASH FLOW FROM OPERATIONS
Cash Flow From Investing
Cash Flow From Financing
CFFO/Operating Income
CFFO/Net Income
CFFO/Sales
Actual Financial Statements
2002
2003
Forecast Financial Statements
2004
2005
2006
Assume
2007
2008
$189,505
$216,929
$247,475
$257,904
$217,509
$195,111
67,685
24,281
0
$77,015
$12,499
$10,123
$88,315
($1,325)
$6,815
102,010
(1,496)
4,476
114,733
(16,279)
3,700
134,637 31.13% $153,486 $174,974
(41,274)
7,931
(809)
$2,287
$3,905
4,311
3,306
5,603
(76,946)
(4,936)
(4,094)
(6,144)
(15,455)
(7,177)
165,910
(160,170)
(27,545)
($45,071)
($1,533)
$2,478
($1,542)
$139,541
$0
$412,726
($184,040)
($30,147)
($87,739)
$6,469
($21,069)
($3,937)
$62,233
$671
$301,813
($218,727)
($96,621)
(125,754)
(1,304)
16,685
1,480
121,608
(671)
376,477
($216,585)
($216,408)
(110,667)
1,304
(7,842)
(11,658)
100,974
4,272
299,352
($139,755)
($141,445)
52,932
(2,397)
(4,113)
1,968
104,867
(4,272)
450,993
($293,348)
($236,909)
2001
0.56
0.88
0.05
2002
2003
2004
2005
2006
1.21
1.90
0.10
0.77
1.22
0.06
0.93
1.46
0.07
0.88
1.38
0.05
2009
2010
2011
2012
2013
2014
2015
2016
$199,471
$227,397
$259,232
$295,525
$336,898
$384,064
$437,833
$499,129
$ 493,049 $ 562,076 $ 640,767 $ 730,474 $ 832,740 $ 949,324 $ 1,082,229 $ 1,233,741 $ 1,406,465 $ 1,603,370
($113,212) ($126,852) ($140,070) ($154,666) ($170,782) ($188,577) ($208,227) ($229,924) ($253,882) ($280,337)
Avg.
1.42 0.96
2.31 1.52
0.07 0.07
2007
0.93
1.54
0.07
2008
0.96
1.59
0.07
2009
0.99
1.64
0.07
2010
2011
1.02
1.69
0.08
2012
1.05
1.75
0.08
2013
1.09
1.80
0.08
2014
1.12
1.86
0.08
2015
1.16
1.92
0.09
Forecasting the cash flow statement was the most difficult statement to
forecast because of lack of pattern. For this reason, we concluded that the cash
flows from operations and cash flow from investing activities were the most
necessary items to forecast for our analysis. To go about forecasting CFFO, we
studied the cash flow statement and noticed a trend in the yearly percent growth
of depreciation and amortization. The average growth rate for this line item
came out to 14% over the last six years. Each individual year’s percent growth
showed little deviation from the mean of 14%. We were assuming that with
plans of future growth, as stated in the FDO 10K, at a steady rate, we were
making a good decision by choosing to forecast out the depreciation and
amortization.
Depreciation and amortization accounted for an average of 31.13% of the
CFFO for the past 4 years on the common size cash flow statement. By
94
2016
1.20
1.99
0.09
Avg.
1.23 1.07
2.05 1.78
0.09 0.08
assuming the average would hold true for future periods, we were able to
forecast out 10 years worth of CFFO by dividing our forecasted depreciation and
amortization by 31.13%. Cash flow from investing activities was forecasted by
computing the year to year change in forecasted non-current assets.
We checked our assumptions by using expense diagnostic ratios. We
calculated that the average CFFO/Operating Income from 2001 to 2006 was .96.
Our forecasted average was equal to 1.07. We were pleased with this number
especially because it is averaging in four extra years of CFFO/OI as compared to
.96. Next, we computed the FDO 2001 to 2006 average CFFO/Net Income ratio
to equal 1.52. For 2007 to 2016, we averaged a ratio of 1.78. Again, we were
pleased with this number which boosts our confidence in our forecasted Family
Dollar cash flow statement.
Conclusion
To the best of our ability, using financial ratios, common sized financial
statements, and our, along with other analysts’, opinions we completed the
forecasting portion of our Family Dollar valuation analysis. We reassured the
credibility of all our forecasted values by applying simple accounting rules to
confirm that our balance sheets balanced, our sales minus costs of goods sold
equaled gross profit, and so on.
95
Cost of Capital Estimate
A company’s assets are either financed by equity or debt. The Weighted
Average Cost of Capital (WACC) is a good method for a company to use. In this
model, the debt and equity portions are weighted by the appropriate cost of
capital. To find the WACC, there are many components that are needed. The
first step in finding out the WACC of a company is to first estimate the cost of
equity, or ke.
Cost of Equity
CAPM is a pricing model that computes the cost of equity for a firm.
There are several figures needed in order to compute CAPM. The risk free rate is
the first of these figures and we attained ours from the latest entry in 5 Year
Treasury Constant Maturity Rate table from the St. Louis FED FRED data as
4.20%.
Our beta of .75 was extracted from our 5 year, 72 month regression
summary table as this model had the highest adjusted R² of 10.53%. This .75
beta was the result of 25 separate regression models. The large number of
regressions which were performed over varying time periods (24 months, 36
months, 48 months, 60 months, and 72 months) and with different constant
maturity t-bill rates from FED FRED data (3 month, 1 year, 2 year, 5 year, and 7
year), were necessary to check the stability of beta. Once all the regressions
were run we looked for the regression with the highest adjusted R². This R²
value is explains the proportion of the variance in the dependent variable that
can be predicted by the independent variable. The higher the adjusted R² the
more explanatory power it has. Our 72 month, 5 year t-bill rate regression gave
us the highest adjusted R² of 10.53% and a corresponding beta of .75. This was
lower than our published beta, which according to Google Finance is .86. While,
96
10.53% is a relatively low explanatory power, our beta is almost perfectly
constant across all of the models. Despite this, with the greatest adjusted R² at
less than 11%, there will be substantial error in FDO’s CAPM model.
5 Year
Time Period
(months)
72
60
48
36
24
Adjusted
R²
Est. Beta ke
10.53%
0.75
9.61%
7.01%
0.85
10.43%
5.69%
1.01
11.72%
4.75%
1.02
11.74%
8.06%
1.26
13.69%
Finally our unadjusted market risk premium (MRP) of 6.80% is the
average MRP of the market from 1926-2005. This raw MRP, however, must be
adjusted by an additional 1.1% from table 8-1 (Palepu pg. 8-4) to account the
added risk premium of a company with a $3.03 billion market cap. This
translates to final MRP of 7.90%. Once all values have been attained they were
simply plugged into the following equation:
Ke=Rf+ β (Rm-Rf)
Ke= cost of equity
Rf= the risk-free rate
β = beta
Rm= the return on the market
97
These calculations ultimately produce a cost of equity of 10.11%. This means
that FDO’s stockholders require at least a 10.11% return on their investments in
FDO as compensation for both risk and the time value of money.
Cost of Debt
Now that we have found our cost of equity, ke, we can know find our
weighted average cost of debt before taxes, or kd. We did this by identifying
each part of our liabilities, long-term and short-term. Then, we found the weight
of each liability by dividing it by Family Dollar’s value of debt, which is
$1,314,636,000.
Our average interest rate that we chose to use for current liabilities was
the published 3 month commercial paper rate in Oct. of 2007
(federalreserve.gov). The long term debt interest rate was disclosed in the FDO
2007 10K. For deferred income taxes we used the 2 year treasury constant
maturity rate also published in October 2007 (federalreserve.gov).
Next we calculated the weighted average interest rate for each liability by
multiplying its weight by the appropriate interest rate. The sum of the computed
weighted average interest rate for each liability yielded a before tax weighted
average cost of debt of 4.724%. Our summarization of calculations are
displayed in the following table.
98
Balance Sheet (in
thousands)
Current Liabilities
LT Liabilities
LT Debt
Deferred Inc. Taxes
Value of Debt
Market Value of Equity
2006
Weight
986111 0.750102
Avg Int.
Rate
4.63
Weight*Avg Int.
Rate
3.472971933
5.33
3.97
1.013588552
0.237133511
Before Tax
Weighted
Avg. Cost
of Debt
4.724
250000 0.190167
78525 0.059731
1314636
3030
Weighted Average Cost of Capital
Determining the weighted average cost of capital before tax is now easy
to do. The formula for the before tax WACC is shown below.
WACCBT= (Vd/Vf) (kd) + (Ve/Vf) (ke)
So,
WACCBT= (1315/4345) * (.04724) + (3030/4345) * (.1011)
All of the numbers in the above formula can be found in the table
provided above. The kd and ke that we found are 4.724 % and 10.11%,
respectively. When solved, Family Dollar’s weighted average cost of capital
before taxes is 8.48%.
In order to find the after-tax weighted average cost of capital is found just
like the before tax weighted average cost of capital but it takes into account
99
taxes. We used our current tax rate of 37.3%, which was provided in Family
Dollar’s 2007 10K.
WACCAT= (Vd/Vf) ((kd)(1-t)) + (Ve/Vf) (ke)
So,
WACCAT= (1315/4345) * (.04724*(1-.373)) + (3030/4345) * (.1011)
When solved, the weighted average cost of capital after taxes equals 7.95%.
Revised Cost of Debt
The changes in liabilities, as a result from capitalization of operating
leases, affected our cost of debt by causing a minor increase to 4.989%.
Specifically there was an increase in long-term liabilities due the addition of
capital lease rights on the balance sheet.
Balance Sheet (in thousands)
Current Liabilities
LT Liabilities
LT Debt
Deferred Inc. Taxes
Value of Debt
Avg Int. Rate
2006
Weight
986111 0.421425485
4.63
1275306 0.545015984
78525 0.033558531
2339942
5.33
3.97
Before Tax
Weighted Avg.
Cost of Debt
Market Value of Equity
Weight*Avg Int. Rate
1.951199996
2.904935196
0.133227367
4.989
3030
100
Revised WACC
WACCBT= (2340/5370) * (.04989) + (3030/5370) * (.1011)
Our adjusted weighted average cost of capital before tax is 7.87%. This
lease adjusted rate is .61% lesser than the original WACC before tax of 8.48%.
WACCAT= (2340/5370) * (.04989*(1-.373)) + (3030/5370) * (.1011)
Our adjusted weighted average cost of capital is equal to 7.067%.
7.067% is only .09% less than the original WACCAT.
Analysis of Valuations
Conducting an evaluation analysis is a very important step in valuing a
company. After looking at how the industry and the company operate and how
the company reports its numbers, the valuation is the decisive factor in whether
or not an investor should invest in a company or not. During the valuation
process, an investor will reveal if the company’s share price is overvalued,
undervalued, or fairly valued. In doing this there are two methods to the
valuation process to take into account.
The first method is the method of comparables. This method is the less
reliable of the two when it comes to making accurate assumptions about the
company because it’s not based on financial theory. Many people use the Method
of Comparables because it is quick and implement. The method of comparables
involves taking ratios of FDO’s competitors, then taking an industry average as a
benchmark. After an industry average is derived, the computed share price is
compared to the benchmark of the given ratio. These ratios include: Trailing and
forward price to earnings, price to book, dividends earnings, P.E.G, Price over
101
EBITDA, Price over Free Cash Flow per Share, and Enterprise Value over
EBITDA.
The second method of the valuation analysis is the intrinsic valuation
method. With this method there is more accuracy in an overvalued, undervalued,
or fairly valued assumption because of the elaborate forecasts and analysis of
assenting years. There are many different models to look at when deriving
instrinsic value including: Discounted Dividends, Discounted Free Cash Flows,
The Residual Income Method, The Residual Income Perpetuity, and the
Abnormal Earnings Approach. All of these have their own separate methods and
calculations for coming up with an intrinsic value.
Method of Comparables
The Method of Comparables involves taking an industry average of each
ratio and comparing that average to the share price of the company being
valued. For valuing Family Dollar, we only took the averages of the 99 Cents
Only and The Dollar Tree because; our other competitor The Dollar General,
recently went private.
Trailing Price to Earnings
Trailing P/E is found by taking the current share price and dividing it by
the last years’ Earnings per Share.
102
P/E (Trailing)
Company
P/E (Trailing)
Est. Stock Price
Family Dollar
$60.646
Dollar General
NA
Dollar Tree
14.732
99 Cent Only
58.645
Average
36.689
UNDERVALUED
We took the P/E ratio for The Dollar Tree and 99 Cents Only and added
them up. We then divided by two to get the average to get 36.8. We then set
this number equal to the trailing P/E of Family Dollar and solved to get an
estimated share price of 60.65. When compared to FDO’s current stock price of
23.24, it shows that our company is undervalued when this method is used.
Forward Price to Earnings
The Forward Price to Earnings Ratio is a calculated by dividing Market
Price per Share by the Expected Earnings per Share. It is important to note that
the forecasted earning per share is used in this calculation.
P/E
(Forecast)
Company
Family Dollar
Dollar General
Dollar Tree
99 Cent Only
Average
EPS
(Forecast)
P/E
(Forecast)
Est. Stock Price
$31.142
NA
2.45
0.35
11.707
25.971
18.839
UNDERVALUED
103
The industry average was calculated by using The Dollar Tree’s and 99
Cent Store’s average P/E forecast, which was 18.84. After taking the average, we
set it equal to Family Dollar’s P/E forecast and solved for P by multiplying FDO’s
P/E by the industry P/E. The equated share price using this method came out to
be $31.14. When compared to FDO’s current share price of 20.23, it is assumed
that the price is undervalued. This is because there is a significant difference in
the two prices and the forecasted share price is larger than the actual.
FDO’s Forecast P/E = Industry Average P/E
FDO’s ‘P’ = Industry Average (P/B) * (FDO’s ‘E’)
Price to Book Value
The Price to Book compares the current stock price (market value) to the
firm’s book value, so to calculate this ratio you take the current share price and
divide it by the book value of the company at the end of the last quarter.
P/B
Company
Est. Stock Price
Family Dollar
Dollar General
$
15.31
NA
Dollar Tree
2.521804115
99 Cent Only
1.214428858
Average
1.868116486
OVERVALUED
After computing this ratio for our competitors and dividing that number by
two (the number of competitors in the industry) we got the average of 1.87. We
104
then took FDO’s P/B and set it equal to the industry average P/E and solved for P
by multiplying industry average P/B by FDO’s B. This computation yielded a stock
price of 15.31, when compared to FDO’S current share price, shows that FDO is
overvalued.
FDO’s P/B = Industry Average P/B
FDO’s ‘P’ = (Industry Average P/B )*( FDO’s ‘B’)
Dividend Yield
The Dividend Yield is used to compute the dividends paid by a company
compared to the share price. Since none of FDO’s competitors pay dividends, we
cannot take an industry average to compute the dividend yield.
PEG
The PEG ratio is used to value a stock price relative to earnings growth.
This can be calculated by taking the P/E ratio and dividing it by the earnings
growth.
PEG
industry average
g
PEG ratio
$
1.07
13.88%
22.09
UNDERVALUED
By taking the PEG of our two competitors and dividing it by two we came
up with an industry average of 1.07. The industry PEG was then set equal to the
FDO’s PEG and solved for P by multiplying the industry average P.E.G by the
105
FDO’s E*G to derive a price of 22.09, which makes the current price of 20.23
slightly undervalued.
FDO’s P/ (E/G) = Industry Average P.E.G.
FDO’s ‘P’ = (Industry Average P.E.G )* (FDO’s ‘E’ * ‘G’)
P/EBITDA
P/ EBITDA are used to calculate the estimated price per share for the
firm. This is calculated by dividing the current price by the EBITDA.
P/EBITDA
Company
Family Dollar
Dollar General
Dollar Tree
99 Cent Only
Average
Est. Stock Price
$3.971920172
0.058358087
0.279778393
0.16906824
OVERVALUED
The first step to this computation was to take the average P/EBITDA for
the industry. After the average was calculated, we set it equal to Family Dollar’s
P/EBITDA and solved for P by multiplying the industry average P/EBITDA by
FDO’s EBITDA. According to this calculation our estimated stock price was 3.97.
When compared to our actual share price of 20.23, we can see that FDO is
extremely overvalued using this ratio.
The industry average P/EBITDA of .169 was computed and set equal to FDO’s
P/EBITDA to get an estimated stock price of 3.971. When compared to the
current stock price of 20.23, it is assumed that FDO is overvalued.
106
FDO’s P/EBITDA = Industry Average P/EBITDA
FDO’s ‘P’ = (Industry Average P/EBITDA )*( FDO’s EBITDA)
Price/ Free Cash Flows
The Price to Free Cash Flow model is used to compare the share price to
the annual cash flows. To calculate P/FCF, take the current share price and
divide it by the free cash flows.
P/FCF
Company
Family Dollar
Dollar General
Dollar Tree
99 Cent Only
Average
Est. Stock Price
$37.86
n/a
6.696806257
7.593902812
7.145354534
UNDERVALUED
To find an estimated share price using this method, we first took the price
to cash flows of our competitors, added them up and divided by two, to get an
industry average of 7.15. We then set that equal to FDO’s P/FCF. We then
multiplied the industry P/FCF by Family Dollar’s P/FCF to get 37.86, and when
compared to FDO’s current share price of 20.23, the price is undervalued.
107
FDO’s P/FCF = Industry Average P/FCF
FDO’s ‘P’ = Industry Average P/FCF * FDO’s FCF
Enterprise Value/EBITDA
Enterprise Value/EBITDA is calculated by taking the sum of the price per
share and the book value of liabilities, and the subtracting its cash and cash
equivalents.
Enterprise Value/EBITDA
Company
Family Dollar
Dollar General
Dollar Tree
99 Cent Only
Average
Est. Stock Price
$31.85
n/a
6.203
14.39
20.593
UNDERVALUED
To find an estimated share price using this method, first an industry
average is needed. This is found by calculating the Enterprise Value/EBITDA for
the competitors and dividing that number by two. The calculated industry
average by doing this is 20.593. To find the estimated share price, we took the
industry average and multiplied it by FDO’s Enterprise Value/EBITDA. We then
subtracted the book value of liabilities and added cash to get 4,474,275. Next,
we divided this by the total number of shares outstanding, and derived the
estimated stock price of 31.85. When compared to FDO’s current share price of
20.23, the price of the stock is undervalued.
108
Overall Method of Comparables Valuation
The overall assumption using The Method of Comparables is that Family
Dollars’ stock price of 20.23 is undervalued. Out of all the ratios, only the P/Book
Value and the P/EBITDA showed the price to be overvalued. The rest of the
ratios showed the price to be undervalued. There are many reasons why these
estimations and assumptions are not reliable. One, for example is the
calculations are made on the surface content of information like pre- computed
numbers without ever taking into account the reasoning behind those numbers.
The companies' accounting strategies, industry overviews, and other crucial
underlying information is left out of the calculation and assumption. These
calculations are also based on past information and have no insight to forward
looking predictions. The same holds when comparing and averaging the
competitor’s numbers, which can cause a certain level of distortion. To better
analyze whether or not the price is overvalued or undervalued, we need to look
at the Intrinsic Valuations that take into account forward looking estimations.
Intrinsic Valuations
Intrinsic Value is defined as “the actual value of a company or an asset
based on an underlying perception of its true value including all aspects of the
business, in terms of both tangible and intangible factors” (Investopedia.com).
The Intrinsic Valuation models explain better of how much value is in a company.
These models go more in-depth and are extremely more reliable than the
previous values from the Method of Comparables. The intrinsic valuation models
include the Discounted Dividends model, the Free Cash Flow model, the Residual
Income model, the Long Run Return on Equity Residual Income model, and the
Abnormal Earnings Growth model.
109
Discounted Dividends Model
The purpose of the Discounted Dividends Model is to value a firm based
on the present value of all predicted future dividend payments. According to
investopedia.com the DDM is “one of the oldest, most conservative methods of
valuing stocks.” Many assumptions such as future dividend payments, riskadjusted discount rates and growth rates are needed to use the model. The
main point behind the DDM is that a stock is not more valuable than all current
and future generated dividends that a shareholder will receive as a return.
Sensitivity Analysis
g
0.06
ke 0.08
0.09
0.1011
0.12
0.14
0
$19.62
$14.24
$12.47
$10.93
$8.99
$7.53
0.03
$33.46
$19.58
$16.14
$13.47
$10.46
$8.43
0.05
$88.82
$29.09
$21.65
$16.82
$12.14
$9.35
0.07
N/A
$76.61
$38.18
$24.48
$15.17
$10.81
<19.24
>27.24
overvalued
undervalued
0.1
N/A
N/A
N/A
$558.20
$31.05
$15.72
November 2007 share price $23.24
In order to value Family Dollar using the DDM, we started by forecasting
out dividends. After studying the FDO 10k reports, we calculated the percentage
of net income that dividends represented for years 2001 to 2006. We were
pleased to observe a trend with an average of 24% dividends of net income for
the past 6 years. Assuming a 24% average for the next ten years, we were able
to forecast out future dividends for 2007 to 2016. Satisfied with the results, we
discounted back the future dividend payments, using our cost of equity 10.11%,
to present values. The sum of the present value of each year’s dividends was
then computed, yielding $707,582. For infinite number of future years,
110
beginning in 2017, we used the perpetuity equation to value FDO. We chose to
cut our future dividend growth rate in half to a conservative 5% for the
perpetuity. A conservative 5% growth rate was assumed to account for
unforeseen factors that can affect distant future activity. Dividing the terminal
year’s dividends by the difference of the cost of equity minus 5% growth gave us
our perpetuity in 2016 dollars. The present value of the perpetuity $3,857,390
equaled a value of $1,472,400. Adding the present value of the perpetuity to the
present value of 2007-2016 dividends gave us a total value of FDO. By dividing
the total dollar figure by year 2007 shares outstanding 140,473, the DDM
provided us with an FDO share value of $15.52 at the end of 2006 (FDO10K
2007). FDO’s observed share price, along with total shares outstanding, were
obtained November 4, 2007 which prompted us to grow $15.52 into current
dollars. Being that, thus, the DDM provided us with a November 4, 2007 implied
share price of $16.82.
The observed stock price per share as of November 4, 2007 equaled
$23.24 (yahoo finance). According the discounted dividends model, Family
Dollar inc. stock is trading for $6.42 per share over its true value of $16.82 per
share. Investors who observe the FDO figures from the DDM would say that
Family Dollar inc. is overvalued. Noting that 68% of the estimated total value of
FDO is derived from the much speculated perpetuity should be an indicator of
the DDM lack of explanatory power.
Free Cash Flow Model
The Discounted Free Cash Flow Model is another intrinsic valuation model
that is similar the Discounted Dividend Model. This model explains a company’s
stock price in terms of its forecasted cash flows to the firm and the cost of
capital.
111
Sensitivity Analysis
g
WACC
0
0.01
0.03
0.05
0.07
$91.76
$103.00
$142.33
$260.31
0.0848
$70.23
$76.71
$96.78
$139.92
0.09
$64.44
$69.88
$86.22
$118.90
0.1
$55.11
$59.08
$70.45
$90.90
0.11
$47.60
$50.57
$58.74
$72.37
< 19.24 overvalued
> 27.24 undervalued
Fairly valued
In order to do the Free Cash Flow Model for Family Dollar we used our
FDO forecasted cash flow from operations (CFFO), forecasted cash flow from
investing (CFFI), the company’s before tax weighted average cost of capital
(WACC), and an observed share price. By subtracting the CFFO and the CFFI we
determined the free cash flows to the firm. Free cash flow to the firm is the
amount of money the company has left over after sustaining or expanding its
assets. Then, using our WACCbt, we computed the present value of annual free
cash flow to the firm and summed the figures for a total present value of free
cash flows. Next, we calculated the value of equity by taking the value of the
firm and subtracting the book value of Family Dollar’s liabilities. The estimated
value of the firm was equal to the sum of our total present value of free cash
flows and present value of the terminal year’s free cash flow figure. Once we
computed market value of equity, we knew how to find the company’s estimated
value per share by dividing by shares outstanding. The estimated value per
share was compared to the company’s observed share price of $23.24. Our
final step was constructing a sensitivity analysis table by varying Family Dollar’s
WACC and growth rate to observe stock price changes.
112
In conclusion, the free cash flow model does a poor job of explaining a
company’s stock price, especially for Family Dollar. This could be a result of
estimation errors in forecasting. The Free Cash Flow model states that Family
Dollar is extremely undervalued relative to its current share price of $23.24.
Residual Income Model
The Residual Income Model is another valuation model that is used in
valuation analysis. This model is based on foundations in financial theory and is
consistent with the Modigliani and Miller Model. The RI model helps determine if
a company is overvalued, undervalued, or fairly valued as do the previous
valuation models. The Residual Income model has the highest degree of
explanatory power in comparison to the previous valuation models we used, with
potential for explaining 50% or stock price variability.
g
0.08
0.09
0.1011
0.12
0.13
0.14
0
44.93
37.76
31.62
24.06
21.07
18.58
-0.1
33.40
29.69
26.18
21.33
19.23
17.39
Sensitivity
Analysis
-0.2
30.10
27.19
24.35
20.31
18.51
16.91
-0.3
28.54
25.97
23.44
19.78
18.13
16.64
-0.4
27.63
25.25
22.89
19.45
17.89
16.47
-0.5
27.03
24.77
22.52
19.23
17.72
16.36
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of $23.14
We used our ke of 10.11% that we calculated with CAPM and used Family
Dollar’s observed share price of $23.24. Using our FDO forecasted earnings and
dividends for the next ten years allowed us to derive their total book value of
equity. Then, we needed to find the “normal” earnings, or benchmark earnings,
113
by taking the previous year’s book value of equity multiplied by ke of 10.11%.
The next step is to find residual income values which is found by subtracting
actual earnings by the normal, or benchmark, earnings. Then, we found FDO’s
present value factor for each of its forecasted years and brought them back to
the present. We then found the sum of all of the total present value of the
annual residual income. The year by year annual residual income figures will
later come in handy as check figures when running the Abnormal Earnings
Growth model. The continuing terminal value of the perpetuity and the present
value of the terminal value Perpetuity are found next in this model. Once
computed, we added Family Dollar’s total present values of residual income, the
present value of terminal value perpetuity and the initial book value of equity
and divided the sum by current shares outstanding to find Family Dollar’s
estimated price per share.
According to Yahoo! Finance, Family Dollar’s share price for November of
2007 was $23.24. A sensitivity analysis table was constructed by changing our
growth rate and ke in the model and recording the yielded values. This model is
not as sensitive to errors as the previous intrinsic models. Greatly varying the
cost of capital or the growth has little effect to the implied share price. The
Residual Income Model helps us to understand the value of future excess income
after all of the liabilities or debt obligations of the company have been paid off.
This model implies that Family Dollar is fairly valued.
Long Run Return on Equity Residual Income Model
The Long Run Return on Equity Residual model, or the Residual Income
Perpetuity model, is another intrinsic valuation model that is derived from the residual
income model. This model uses a perpetuity equation which was used when we ran the
residual income model. The main components we need for this valuation model is the
book value of equity, the cost of equity, the long run return on equity, and the growth
rate. The residual income perpetuity model measures value through the perpetuity
114
itself.
To find Family Dollar’s book value of equity, we took the 2006 book value of
equity that is recorded on the balance sheet. We then divided the figure by the shares
outstanding to obtain a book value of equity per share of $8.602. The cost of equity was
found above in the section labeled cost of equity. We computed Family Dollar’s cost of
equity to be 10.11%. Family Dollar’s long run return on equity came out to 13.66%.
Also, as noted throughout this whole valuation, Family Dollar’s observed share price is
$23.24. The sensitivity analysis tables for long run residual income perpetuity model
follow.
g
ke
0.12
N/A
N/A
N/A
14.28
4.76
0.06
0.08
0.1011
0.13
0.15
0.14
0.37
0.49
0.75
2.92
N/A
0.16
2.01
2.52
3.42
6.71
20.13
0.18
3.11
3.73
4.73
7.47
12.44
0.2
3.9
4.54
5.51
7.79
10.91
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of $23.24
ROE
ke
0.06
0.08
0.1011
0.13
0.15
0.09
12.9
9.68
7.66
5.96
5.16
0.12
17.2
12.9
10.21
7.94
6.88
0.1366
19.58
14.69
11.62
9.04
7.84
0.16
22.94
17.2
13.61
10.59
9.18
0.18
25.81
19.36
15.32
11.91
10.32
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of $23.24
115
g
ROE
0.09
0.12
0.1366
0.16
0.18
0.12
13.65
N/A
N/A
N/A
0.14
11.06
4.42
0.75
N/A
N/A
0.16
10.22
5.84
3.42
0.18
9.81
6.54
4.73
2.18
0.2
9.57
6.96
5.51
3.48
1.74
N/A
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of $23.24
Running a sensitivity analysis in a similar fashion as the previous analysis’, the
residual income perpetuity model labels FDO’s stock as overvalued. We find this model
to have little explanatory power because of the many assumptions and speculations that
are imbedded in the calculated the perpetuity. We are not going to include this
overvalued share price result in our overall buy, sell or hold recommendation.
Abnormal Earnings Growth Model
The Abnormal Earnings Growth model calculates a firm’s intrinsic value
from a firm’s future earnings along with cumulative dividend earnings based on a
dividend reinvestment plan. The AEG model uses a benchmark earnings figure
each year in order to determine whether value is created or destroyed by the
firm from year to year. Abnormal earnings growth figures are discounted back to
year one as versus year zero like the other models. AEG model is backed by
financial theory by directly linking this model to accounting figures. This can be
seen by observing that the abnormal earnings growth from year to year equal to
the change in residual income from year to year.
116
Sensitivity Analysis
g
Ke
0.08
0.09
0.1011
0.12
0.14
0
50.69
37.24
27.20
16.78
10.57
-0.1
39.50
30.84
23.83
15.87
10.66
-0.2
36.30
28.85
22.69
15.53
10.70
-0.3
34.79
27.88
22.13
15.35
10.72
-0.4
33.91
27.30
21.79
15.24
10.73
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of $23.24
The first step for using the AEG model is to determine cumulative dividend
earnings. Our cumulative dividend earnings were equal to our forecasted
earnings plus D.R.I.P income. D.R.I.P. income was found by multiplying the
previous year’s dividends by our %10.11 cost of equity. Next, we figured our
normal earnings benchmark by multiplying the previous year’s earnings by Ke
plus 1. Subtracting our benchmark earnings for the year from that year’s
cumulative dividends earnings equaled abnormal earnings growth for the
particular year. The annual AEG for each year from 2008 to 2016 were
discounted back to year 1’s dollars using Ke and the present value formula.
Assuming a zero growth rate when calculating the perpetuity, we discounted that
figure back to 2008 dollars as well.
Once we had the sum of our present values of AEG, we added that figure
along with the present value of the perpetuity to 2007 forecasted earnings. The
calculated total of $356,601 was divided by the capitalization rate, equal to Ke,
to figure the intrinsic value of FDO in total dollars. We divided our figured value
by shares outstanding of 147,403 which delivered us an end of 2006 intrinsic
value per share of $25.11. Growing $25.22 by 10 months yielded us the time
consistent implied share price of $27.21.
Our sensitivity analysis helped us to determine that FDO is fairly valued
according to the Abnormal Earnings Growth model using our estimated Ke and
any growth rate from 0 to -.4. Negative growth rates are used because the
117
model is eventually showing a convergence to zero. We proved the consistency
of our valuation models by showing that our AEG per year was equal to the
change in residual income per year.
Annual Change in R.I.
Abnormal Earnings Growth
2008
8771.40
8771.40
2009
2010
2011
2012
2013
2014
9685.38 10694.59 11808.97 13039.47 14398.18 15898.47
9685.38 10694.59 11808.97 13039.47 14398.18 15898.47
2015
2016
17555.09 19384.33
17555.09 19384.33
Overall Conclusion
All in all, we chose to consider only the residual income and AEG models
when concluding an investment recommendation. AEG and Residual Income
models are most accurate because they are linked to earnings, dividends and
book value of liabilities. These items were more easily forecasted than cash
flows. We chose to ignore the results of the long run residual income perpetuity
model because of extreme speculation in determining perpetuity. Because
forecasted cash flows are more prone to error, we assumed the discounted free
cash flow model along with the discounted dividend model were less meaningful
for our intended purpose. According to our intrinsic valuations we would say
that Family Dollar Inc is an undervalued firm.
Credit Analysis
A credit analysis is performed in order to ultimately determine the
likeliness of a firm entering into a financial disaster and not being able to meet
debt obligations. A firm’s credit worthiness is of interest to current and potential
debt holders of the firm. Generally speaking, cost of debt and credit worthiness
should have an inverse relationship because of the demand of greater reward for
taking on greater risk.
118
The Altman Z – score model was the model that we used to predict the
degree of bankruptcy risk of Family Dollar. Altman Z – score is equal to the sum
of five weighted financial ratios. “The model predicts bankruptcy when Z<1.81.
The range between 1.81 and 2.67 is labeled the gray area.”(Palepu and Healy
2008)
The formula is as follows:
Z = 1.2(net working capital/total assets) + 1.4(retained earnings/total
assets) + 3.3(EBIT/total assets) + .6(market cap/book value of total liabilities) +
1.0(sales/total assets)
Z-Score
2002
9.202
2003
10.455
2004
7.235
2005
6.099
2006
5.773
FAMILY DOLLAR
Family Dollar’s debt holders should not be too worried about Family dollar
not fulfilling their debt obligations seeing as the Z – scores are well over 1.81.
The score has been on the decline since 2003, which we found to be mostly an
effect of a shrinking market value of equity.
Revised Z-Score
Family Dollar
Z-Score
Revised Z-Score
2002
9.202
5.753
2003
10.455
6.321
2004
7.235
4.689
2005
6.099
3.986
2006
5.773
3.893
119
The effect of capitalization of operating leases was reflected in the z-score
as a lower score for the past 5 years. The increase in bankruptcy possibility is
mainly a result of an increase in total assets and total liabilities. With a Z-Score
well over 2.67, Family Dollar is still perceived as a very credit worthy firm.
Analyst Recommendation
After a comprehensive analysis of the Family Dollar Inc. and the industry
we have concluded that FDO is currently and undervalued stock and recommend
its purchase. This decision is a result of an extensive industry, accounting,
financial, and valuation analyses. FDO operates in a highly saturated industry in
which their KSF’s and cost leadership strategy allow them to continue to grow.
They have properly linked their KAP’s with their key success factors and keep
disclosure and quality of financial statements at or above industry norms. The
only potential foreseeable problem for FDO is the capitalization of their operating
leases, but this is normal for the rest of the industry and of little concern as long
as the company continues to grow. Both profitability and capital structure ratios
for the company are also inline or outpacing the same ratios of competing firms.
Finally, the intrinsic valuation models that can be heavily weighed upon (Residual
Income, and Abnormal Earnings Growth) both show FDO to be undervalued as of
November 1, 2007.
120
Appendices
2001 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor
2002
1
$141,579 0.949397133
2003
2
$124,267 0.901354916
2004
3
$100,980 0.855743773
2005
4
$73,886 0.812440684
2006
5
$43,864 0.771328856
2007
6
$38,965 0.732297405
2008
7
$38,965 0.695241056
Total PV of Operating Lease Expenses:
Present Value
$134,414.70
$112,008.67
$86,413.01
$60,027.99
$33,833.57
$28,533.60
$27,089.72
$482,321
2002 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor
2003
1
$169,240 0.949397133
2004
2
$146,652 0.901354916
2005
3
$118,929 0.855743773
2006
4
$87,770 0.812440684
2007
5
$54,982 0.771328856
2008
6
$51,375 0.732297405
2009
7
$51,375 0.695241056
Total PV of Operating Lease Expenses:
Present Value
$160,675.97
$132,185.50
$101,772.75
$71,307.92
$42,409.20
$37,621.41
$35,717.66
$581,690
2003 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor
2004
1
$190,840 0.949397133
2005
2
$167,434 0.901354916
2006
3
$136,444 0.855743773
2007
4
$102,997 0.812440684
2008
5
$67,204 0.771328856
2009
6
$65,823 0.732297405
2010
7
$65,823 0.695241056
Total PV of Operating Lease Expenses:
Present Value
$181,182.95
$150,917.46
$116,761.10
$83,678.95
$51,836.38
$48,202.01
$45,762.85
$678,342
121
2004 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor Present Value
2005
1
$221,468 0.949397133
$210,261.08
2006
2
$196,109 0.901354916
$176,763.81
2007
3
$162,856 0.855743773
$139,363.01
2008
4
$125,851 0.812440684
$102,246.47
2009
5
$88,680 0.771328856
$68,401.44
2010
6
$86,286 0.732297405
$63,187.01
2011
7
$86,286 0.695241056
$59,989.57
Total PV of Operating Lease Expenses:
$820,212.40
2005 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor Present Value
2006
1
$252,588 0.949397133
$239,806.32
2007
2
$225,649 0.901354916
$203,389.84
2008
3
$188,636 0.855743773
$161,424.08
2009
4
$150,096 0.812440684
$121,944.10
2010
5
$107,522 0.771328856
$82,934.82
2011
6
$105,660 0.732297405
$77,374.18
2012
7
$105,660 0.695241056
$73,458.82
Total PV of Operating Lease Expenses:
$960,332.16
2006 Capitalization of Operating Leases, Discount Rate 5.33%
Year
T Commitment
PV Factor
2007
1
$271,811 0.949397133
2008
2
$241,454 0.901354916
2009
3
$203,066 0.855743773
2010
4
$159,912 0.812440684
2011
5
$114,104 0.771328856
2012
6
$110,617 0.732297405
2013
7
$110,617 0.695241056
Total PV of Operating Lease Expenses:
Present Value
$258,056.58
$217,635.75
$173,772.46
$129,919.01
$88,011.71
$81,004.54
$76,905.48
$1,025,306
122
Family Dollar’s Forecasted Income Statement
Actual Financial Statements
(in thousands)
2001
2002
2003
2004
2005
2006
Forecast Financial Statements
Assume 2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Years ended
Net sales
Cost of sales
2001 31-Aug-02 30-Aug-03 28-Aug-04 27-Aug-05 26-Aug-06
$3,665,362 $4,162,652 $4,750,171 $5,281,888 $5,824,808 $6,394,772 10.42% $7,061,107 $7,796,875 $8,609,309 $9,506,399 $10,496,966 $11,590,750 $12,798,506 $14,132,110 $15,604,676 $17,230,683
$2,439,261 $2,766,733 $3,145,788 $3,496,278 $3,908,569 $4,276,466 66.57% $4,700,579 $5,190,379 $5,731,217 $6,328,410 $6,987,830 $7,715,962 $8,519,965 $9,407,746 $10,388,033 $11,470,466
Gross Profit
$1,226,101 $1,395,919 $1,604,383 $1,785,610 $1,916,239 $2,118,306
$2,360,528 $2,606,495 $2,878,092 $3,177,989 $3,509,136 $3,874,788 $4,278,540 $4,724,364 $5,216,643 $5,760,217
Selling, general and administrative
Litigation charge (Note 8)
Cost of sales and operating expenses
$927,679 $1,054,298 $1,214,658 $1,382,248 $1,577,429 $1,756,001 25.89% $1,828,121 $2,018,611 $2,228,950 $2,461,207
$0
$0
$0
$0
$0 $45,000
$3,366,940 $3,821,031 $4,360,446 $4,878,526 $5,485,998 $6,077,467
$6,528,700 $7,208,990 $7,960,167 $8,789,616
$2,717,664
Operating profit
$298,422 $341,621 $389,725 $403,362
$791,471
$873,943
$965,007 $1,065,561 $1,176,593 $1,299,193
$476,562
$526,220
$581,052
Interest income
Interest expense
$0
$0
$0
$0
$0
$0
$3,300
$0
$338,810 $317,305 7.54% $532,407 $587,884 $649,142 $716,782
$3,985
$0
$298,422 $341,621 $389,725 $406,662
$342,795 $311,144
Income taxes
$108,917
$125,286
Net income
$189,505 $216,929 $247,475 $257,904
$142,250
$148,758
$3,313,533
$3,658,803
$4,040,051
$4,461,024
$9,705,495 $10,716,807 $11,833,498 $13,066,549 $14,428,083 $15,931,490
$6,934
$13,095
Income before income taxes
$124,692
$3,000,845
$116,033
$217,509 $195,111 4.54%
$320,574
$353,978
$390,863
$431,591
$641,598
123
$708,452
$782,273
Forecasted Income Statement with Capital Lease Corrections
Income Statement (in thousands, except per share amounts)
with lease adjustments
0.33534367
Actual Financial Statements
2001
Years ended
Net sales
Cost of sales
2005
Sales Growth
14%
14%
11%
10%
2001 31-Aug-02 30-Aug-03 28-Aug-04 27-Aug-05
$3,665,362 $4,162,652 $4,750,171 $5,281,888 $5,824,808
$2,439,261 $2,766,733 $3,145,788 $3,496,278 $3,908,569
Gross Profit
Reversal of Operating Lease Rent
Less: Capital Lease Depreciation Expense
Selling, general and administrative
Litigation charge (Note 8)
Cost of sales and operating expenses
Operating profit
2002
2003
2004
Forecast Financial Statements
2006 Assume 2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
10%
26-Aug-06
$6,394,772 10.42% $7,061,107 $7,796,875 $8,609,309 $9,506,399 $10,496,966 $11,590,750 $12,798,506 $14,132,110 $15,604,676 $17,230,683
$4,276,466 66.57% $4,700,579 $5,190,379 $5,731,217 $6,328,410 $6,987,830 $7,715,962 $8,519,965 $9,407,746 $10,388,033 $11,470,466
$1,226,101 $1,395,919 $1,604,383 $1,785,610 $1,916,239 $2,118,306
$2,360,528 $2,606,495 $2,878,092 $3,177,989 $3,509,136 $3,874,788 $4,278,540 $4,724,364 $5,216,643 $5,760,217
$158,949 $185,372 $212,866 $242,910 $279,232 $298,362
$133,241 $154,368 $176,710 $199,193 $228,046 $243,713
$927,679 $1,054,298 $1,214,658 $1,382,248 $1,577,429 $1,756,001 25.89% $1,828,121 $2,018,611 $2,228,950 $2,461,207 $2,717,664 $3,000,845 $3,313,533 $3,658,803 $4,040,051 $4,461,024
$0
$0
$0
$0
$0 $45,000
$3,366,940 $4,160,771 $4,750,022 $5,320,629 $5,993,276 $6,619,542
$6,528,700 $7,208,990 $7,960,167 $8,789,616 $9,705,495 $10,716,807 $11,833,498 $13,066,549 $14,428,083 $15,931,490
$324,130
$372,625
$425,881
$0
$25,708
$0
$0
$31,004
$0
$0
$36,156
$0
Income before income taxes
tax rate
Income taxes
$298,422
36%
$108,917
$341,621
37%
$124,692
$389,725
37%
$142,250
$406,662 $342,795 $311,144
37%
37%
37%
$148,758 $125,286 $116,033
Net income
$189,505
$216,929
$247,475
$257,904 $217,509 $195,111 4.54%
Net income per common share basic
Average shares basic
Net income per common share diluted
Average shares diluted
$1
$171,568
$1
$172,774
$1.26
$172,800
$1.25
$174,049
$1.44
$172,346
$1.43
$173,354
$1.51
$170,770
$1.50
$171,624
Interest income
Implied Interest Expense on lease payment
Interest expense
$447,079 $389,996 $371,954 7.54%
$3,300
$43,717
$0
$532,407
$587,884
$649,142
$716,782
$791,471
$873,943
$965,007 $1,065,561 $1,176,593 $1,299,193
$320,574
$353,978
$390,863
$431,591
$476,562
$526,220
$581,052
$3,985 $6,934
$51,186 $54,649
$0 -$13,095
$641,598
$1.30
$1.26
$166,791 $154,967
$1.30
$1.26
$167,092 $155,124
124
$708,452
$782,273
Family Dollar’s Income Statement (Common Size)
Year End
Sales
Cost of Sales
Gross Profit on Sales
S,G, and A Expenses
Operating Income
Interest Income
Interest Expense
Income Before Taxes
Income Tax
Net Income
2001
100.00%
66.55%
33.45%
25.31%
8.14%
0.00%
0.00%
8.14%
2.97%
5.17%
2002
100.00%
66.47%
33.53%
25.33%
8.21%
0.00%
0.00%
8.21%
3.00%
5.21%
2003
100.00%
66.22%
33.78%
25.57%
8.20%
0.00%
0.00%
8.20%
2.99%
5.21%
2004
100.00%
66.19%
33.81%
26.17%
7.64%
0.06%
0.00%
7.70%
2.82%
4.88%
2005
100.00%
67.10%
32.90%
27.08%
5.82%
0.07%
0.00%
5.89%
2.15%
3.73%
2006
100.00%
66.87%
33.13%
28.16%
4.96%
0.11%
0.20%
4.87%
1.81%
3.05%
125
Family Dollar’s Forecasted Balance Sheet
(in thousands, except per share and share
amounts)
Assets
Current assets:
Cash and cash equivalents
Investment securities (Note 2)
Merchandise inventories
Deferred income taxes (Note 6)
Income tax refund receivable
Prepayments and other current assets
Total current assets
2001
Actual Financial Statements
2002
2003
2004
2005
2006
Assume
2007
Forecast Financial Statements
2008
2009
2010
2011
2012
2013
2014
2015
2016
$21,753
$0
$721,560
$43,985
$4,936
$15,031
$807,265
$220,265
$0
$766,631
$49,941
$6,469
$12,553
$1,055,859
$206,731
$0
$854,370
$61,769
$0
$33,622
$1,156,492
$87,023
$120,840
$980,124
$84,084
$1,304
$16,937
$1,290,312
$105,175
$33,530
$1,090,791
$100,493
$0
$24,779
$1,354,768
$79,727
$136,505
$1,037,859
3.76 $1,250,154
$133,468
$2,397
$28,892
$1,418,848 57.76% $1,664,692
$1,380,420
$1,524,260
$1,683,088
$1,858,465
$2,052,118
$2,265,948
$2,502,060
$2,762,775
$3,050,656
$1,838,153
$2,029,689
$2,241,182
$2,474,713
$2,732,578
$3,017,313
$3,331,717
$3,678,882
$4,062,221
$580,879
$11,601
$592,480
$685,617
$13,143
$698,760
$812,123
$17,080
$829,203
$918,449
$15,600
$934,049
$1,027,475
$27,258
$1,054,733
$1,077,608 41.35% $1,191,742
$26,573
$25,651
$1,104,181 42.24% $1,217,393
$1,315,921
$28,323
$1,344,245
$1,453,041
$31,275
$1,484,315
$1,604,447
$34,533
$1,638,981
$1,771,631
$38,132
$1,809,763
$1,956,235
$42,105
$1,998,340
$2,160,074
$46,493
$2,206,567
$2,385,154
$51,337
$2,436,491
$2,633,687
$56,686
$2,690,373
$2,908,117
$62,593
$2,970,710
$1,399,745
$1,754,619
$1,985,695
$2,224,361
$2,409,501
$2,523,029
$3,182,398
$3,514,004
$3,880,163
$4,284,476
$4,730,918
$5,223,880
$5,768,208
$6,369,255
$7,032,932
$264,965
$12,329
$0
$390,294
$0
$50,436
$381,164
$149,616
$0
$530,780
$0
$68,891
$401,799
$192,861
$671
$595,331
$0
$79,395
$534,405
$266,180
$0
$800,585
$0
$86,694
$574,831
$315,508
$4,272
$894,611
$0
$86,824
$556,531
$429,580
$0
$986,111
$250,000
$78,525
$749,342
$827,423
$913,641
$1,008,842
$1,113,964
$1,230,039
$1,358,209
$1,499,734
$1,656,006
$1,828,562
$50,436
$68,891
$79,395
$86,694
$86,824
$328,525
$680,705
$633,905
$582,228
$525,167
$462,159
$392,586
$315,764
$230,937
$137,271
$33,845
$440,730
$599,671
$674,726
$887,279
$981,435
$1,314,636
$1,430,047
$1,461,328
$1,495,869
$1,534,009
$1,576,123
$1,622,625
$1,673,973
$1,730,671
$1,793,277
$1,862,407
Common stock, $.10 par; authorized
600,000,000 shares; issued 178,559,411
shares at August 26, 2006, and 188,871,738
shares at August 27, 2005, and outstanding
150,210,484 shares at August 26, 2006, and
165, 262,513 shares at August 27, 2005
Capital in excess of par
Retained earnings
Total
$18,454
$40,318
$945,192
$1,003,964
$18,583
$63,294
$1,118,015
$1,199,892
$18,691
$87,457
$1,315,600
$1,421,748
18,767
106,853
1,498,890
$1,624,510
$18,887
$133,743
$1,654,861
$1,807,491
$17,856
$140,829
$1,546,366
$1,705,051
$1,790,010
$2,059,042
$2,356,108
$2,684,127
$3,046,326
$3,446,266
$3,887,880
$4,375,510
$4,913,951
$5,508,498
Less: common stock held in treasury, at cost
(28,348,927 shares at August 26, 2006, and
23,609,225 shares at August 27, 2005
Total shareholders equity
$44,949
$959,015
$44,944
$1,154,948
$110,779
$1,310,969
287,428
$1,337,082
$379,425
$1,428,066
$496,658
$1,208,393
$1,452,037
$1,721,069
$2,018,135
$2,346,154
$2,708,353
$3,108,293
$3,549,907
$4,037,537
$4,575,978
$5,170,525
Total Liabilities and Shareholders Equity
$1,399,745
$1,754,619
$1,985,695
$2,224,361
$2,409,501
$2,523,029
$2,882,085
$3,182,398
$3,514,004
$3,880,163
$4,284,476
$4,730,918
$5,223,880
$5,768,208
$6,369,255
$7,032,932
Property and equipment, net (Note 3)
Other assets
Non-Current Assets
Total Assets
Liabilities and Shareholders Equity
Current liabilities:
Accounts payable
Accrued liabilities (Note 5)
Income taxes payable
Total current liabilities
Long-term debt (Note 4)
Deferred income taxes (Note 6)
Non-Current Liabilities (forecast plug)
TOTAL LIABILITIES Forecast plug
2.45 $2,882,085
26%
Shareholders equity: (Notes 9, 10 and 11)
Preferred stock, $1 par; authorized and
unissued 500,000 shares
126
Family Dollar’s Balance Sheet (Common Size)
(in thousands, except per share and share
amounts)
Assets
Current assets:
Cash and cash equivalents
Investment securities (Note 2)
Merchandise inventories
Deferred income taxes (Note 6)
Income tax refund receivable
Prepayments and other current assets
Total current assets
Property and equipment, net (Note 3)
Other assets
Non-Current Assets
Total Assets
Liabilities and Shareholders Equity
Current liabilities:
Accounts payable
Accrued liabilities (Note 5)
Income taxes payable
Total current liabilities
Long-term debt (Note 4)
Deferred income taxes (Note 6)
Non-Current Liabilities
TOTAL LIABILITIES
Shareholders equity: (Notes 9, 10 and 11)
Preferred stock, $1 par; authorized and
unissued 500,000 shares
Common stock, $.10 par; authorized
600,000,000
Actual Financial Statements
2002
2003
2001
1.16%
11.70%
10.98%
38.34%
2.34%
0.26%
0.80%
42.89%
32.81%
2.14%
0.28%
0.54%
45.19%
30.86%
0.62%
57.11%
100%
2004
2005
2006
32.07%
2.32%
0.00%
1.26%
43.41%
4.62%
3.97%
32.19%
2.76%
0.04%
0.56%
42.38%
5.59%
1.10%
32.37%
2.98%
0.00%
0.74%
40.20%
4.24%
4.48%
29.25%
3.76%
0.07%
0.81%
39.99%
29.35%
0.56%
54.81%
100%
30.48%
0.64%
56.59%
100%
30.17%
0.51%
57.62%
100%
30.49%
0.81%
59.80%
100%
30.37%
0.75%
60.01%
100%
14%
1%
0%
20.74%
16.31%
6.40%
0.00%
22.72%
15.08%
7.24%
0.03%
22.35%
17.55%
8.74%
0.00%
26.30%
17.06%
9.36%
0.13%
26.55%
3%
28%
49%
2.95%
27.85%
51%
2.98%
28.44%
51%
2.85%
29.79%
56%
2.58%
31.07%
58%
15.68%
12.11%
0.00%
27.79%
7.05%
2.21%
38.15%
66%
1%
0.80%
0.70%
0.62%
0.56%
0.50%
2%
50%
53%
2%
2.71%
47.85%
51.36%
1.92%
3.28%
49.38%
53.37%
4.16%
3.51%
49.23%
53.36%
9.44%
3.97%
49.11%
53.64%
11.26%
3.97%
43.58%
48.05%
14.00%
51%
49.43%
49.21%
43.92%
42.38%
34.06%
100%
100.00%
100.00%
100.00%
100.00%
100.00%
shares; issued 178,559,411 shares at August
26, 2006, and 188,871,738 shares at August
27, 2005,
and outstanding 150,210,484 shares at
August 26, 2006, and 165,262,513 shares
at August 27, 2005
Capital in excess of par
Retained earnings
Total
Less: common stock held in treasury, at
cost (28,348,927 shares at August 26, 2006,
and 23,609,225 shares at August 27, 2005)
Total shareholders equity
Total Liabilities and Shareholders Equity
127
Forecasted Balance Sheet with Capital Lease Adjustments
Balance Sheet
With lease adjustments
(in thousands, except per share and share
amounts)
Assets
Current assets:
Cash and cash equivalents
Investment securities (Note 2)
Merchandise inventories
Deferred income taxes (Note 6)
Income tax refund receivable
Prepayments and other current assets
Total current assets
2001
Actual Financial Statements
2002
2003
2004
2005
2006
Assume
2007
Forecast Financial Statements
2008
2009
2010
2011
2012
2013
2014
2015
2016
$21,753
$0
$721,560
$43,985
$4,936
$15,031
$807,265
$220,265
$0
$766,631
$49,941
$6,469
$12,553
$1,055,859
$206,731
$0
$854,370
$61,769
$0
$33,622
$1,156,492
$87,023
$120,840
$980,124
$84,084
$1,304
$16,937
$1,290,312
$105,175
$33,530
$1,090,791
$100,493
$0
$24,779
$1,354,768
$79,727
$136,505
$1,037,859
$133,468
$2,397
$28,892
$1,418,848
3.76
$1,250,154
$1,380,420
$1,524,260
$1,683,088
$1,858,465
$2,052,118
$2,265,948
$2,502,060
$2,762,775
$3,050,656
42.34%
$1,660,929
$1,833,998
$2,025,101
$2,236,116
$2,469,120
$2,726,402
$3,010,493
$3,324,186
$3,670,567
$4,053,040
Property and equipment, net (Note 3)
Other assets
Capital Lease Rights
Non-Current Assets
$580,879
$11,601
$482,321
$1,074,801
$685,617
$13,143
$581,690
$1,280,450
$812,123
$17,080
$678,342
$1,507,545
$918,449
$15,600
$820,212
$1,754,261
$1,027,475
$27,258
$960,332
$2,015,065
$1,077,608
$26,573
$1,025,306
$2,129,487
57.66%
$2,261,908
$2,497,599
$2,757,849
$3,045,216
$3,362,528
$3,712,903
$4,099,788
$4,526,986
$4,998,698
$5,519,562
Total Assets
$1,882,066
$2,336,309
$2,664,037
$3,044,573
$3,369,833
$3,548,335
1.80
$3,922,837
$4,331,597
$4,782,949
$5,281,333
$5,831,648
$6,439,305
$7,110,281
$7,851,172
$8,669,264
$9,572,602
Liabilities and Shareholders Equity
Current liabilities:
Accounts payable
Accrued liabilities (Note 5)
Income taxes payable
Total current liabilities
Long-term debt (Note 4)
Deferred income taxes (Note 6)
Capital Lease Long-Term Debt
$264,965
$12,329
$0
$390,294
$0
$50,436
$482,321
$381,164
$149,616
$0
$530,780
$0
$68,891
$581,690
$401,799
$192,861
$671
$595,331
$0
$79,395
$678,342
$534,405
$266,180
$0
$800,585
$0
$86,694
$820,212
$574,831
$315,508
$4,272
$894,611
$0
$86,824
$960,332
$556,531
$429,580
$0
$986,111
$250,000
$78,525
$1,025,306
Non-Current Liabilities (forecast plug)
$532,757
$650,581
$757,737
$906,906
$1,047,156
$1,353,831
$1,450,862
$1,484,312
$1,521,248
$1,562,032
$1,607,066
$1,656,793
$1,711,701
$1,772,330
$1,839,277
$1,913,200
TOTAL LIABILITIES Forecast plug
$923,051
$1,181,361
$1,353,068
$1,707,491
$1,941,767
$2,339,942
$2,470,800
$2,610,528
$2,764,815
$2,935,179
$3,123,295
$3,331,012
$3,560,374
$3,813,635
$4,093,286
$4,402,077
Common stock, $.10 par; authorized
600,000,000 shares; issued 178,559,411
shares at August 26, 2006, and 188,871,738
shares at August 27, 2005, and outstanding
150,210,484 shares at August 26, 2006, and
165, 262,513 shares at August 27, 2005
Capital in excess of par
Retained earnings
Total
$18,454
$40,318
$945,192
$1,003,964
$18,583
$63,294
$1,118,015
$1,199,892
$18,691
$87,457
$1,315,600
$1,421,748
18,767
106,853
1,498,890
$1,624,510
$18,887
$133,743
$1,654,861
$1,807,491
$17,856
$140,829
$1,546,366
$1,705,051
$1,790,010
$2,059,042
$2,356,108
$2,684,127
$3,046,326
$3,446,266
$3,887,880
$4,375,510
$4,913,951
$5,508,498
Less: common stock held in treasury, at cost
(28,348,927 shares at August 26, 2006, and
23,609,225 shares at August 27, 2005
Total shareholders equity
$44,949
$959,015
$44,944
$1,154,948
$110,779
$1,310,969
287,428
$1,337,082
$379,425
$1,428,066
$496,658
$1,208,393
$1,452,037
$1,882,066
$2,336,309
$2,664,037
$3,044,573
$3,369,833
$3,548,335
$3,922,837
26%
$1,275,306
$1,019,938
$1,126,215
$1,243,567
$1,373,147
$1,516,228
$1,674,219
$1,848,673
$2,041,305
$2,254,009
$2,488,876
Shareholders equity: (Notes 9, 10 and 11)
Preferred stock, $1 par; authorized and
unissued 500,000 shares
Total Liabilities and Shareholders Equity
$1,721,069
$4,331,597
$2,018,135
$4,782,949
$2,346,154
$5,281,333
$2,708,353
$5,831,648
$3,108,293
$6,439,305
$3,549,907
$7,110,281
$4,037,537
$7,851,172
128
$4,575,978
$8,669,264
$5,170,525
$9,572,602
Family Dollar’s Statement of Cash Flows
2001
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization
Deferred income taxes
Stock-based compensation expense, including
tax benefits
Loss on disposition of property and equipment
Changes in operating assets and liabilities:
Merchandise inventories
Income tax refund receivable
Prepayments and other current assets
Other assets
Accounts payable and accrued liabilities
Income taxes payable
CASH FLOW FROM OPERATIONS
Cash Flow From Investing
Cash Flow From Financing
CFFO/Operating Income
CFFO/Net Income
CFFO/Sales
Actual Financial Statements
2002
2003
Forecast Financial Statements
2004
2005
2006
Assume
2007
2008
$189,505
$216,929
$247,475
$257,904
$217,509
$195,111
67,685
24,281
0
$77,015
$12,499
$10,123
$88,315
($1,325)
$6,815
102,010
(1,496)
4,476
114,733
(16,279)
3,700
134,637 31.13% $153,486 $174,974
(41,274)
7,931
(809)
$2,287
$3,905
4,311
3,306
5,603
(76,946)
(4,936)
(4,094)
(6,144)
(15,455)
(7,177)
165,910
(160,170)
(27,545)
($45,071)
($1,533)
$2,478
($1,542)
$139,541
$0
$412,726
($184,040)
($30,147)
($87,739)
$6,469
($21,069)
($3,937)
$62,233
$671
$301,813
($218,727)
($96,621)
(125,754)
(1,304)
16,685
1,480
121,608
(671)
376,477
($216,585)
($216,408)
(110,667)
1,304
(7,842)
(11,658)
100,974
4,272
299,352
($139,755)
($141,445)
52,932
(2,397)
(4,113)
1,968
104,867
(4,272)
450,993
($293,348)
($236,909)
2001
0.56
0.88
0.05
2002
2003
2004
2005
2006
1.21
1.90
0.10
0.77
1.22
0.06
0.93
1.46
0.07
0.88
1.38
0.05
2009
$199,471
2010
2011
2012
2013
2014
2015
2016
$227,397
$259,232
$295,525
$336,898
$384,064
$437,833
$499,129
$ 493,049 $ 562,076 $ 640,767 $ 730,474 $ 832,740 $ 949,324 $ 1,082,229 $ 1,233,741 $ 1,406,465 $ 1,603,370
($113,212) ($126,852) ($140,070) ($154,666) ($170,782) ($188,577) ($208,227) ($229,924) ($253,882) ($280,337)
Avg.
1.42 0.96
2.31 1.52
0.07 0.07
2007
0.93
1.54
0.07
2008
0.96
1.59
0.07
2009
0.99
1.64
0.07
2010
2011
1.02
1.69
0.08
2012
1.05
1.75
0.08
2013
1.09
1.80
0.08
2014
1.12
1.86
0.08
2015
1.16
1.92
0.09
129
2016
1.20
1.99
0.09
Avg.
1.23 1.07
2.05 1.78
0.09 0.08
Family Dollar’s Statement of Cash Flows (Common Size)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization
Deferred income taxes
Stock-based compensation expense, including
tax benefits
Loss on disposition of property and equipment
Changes in operating assets and liabilities:
Merchandise inventories
Income tax refund receivable
Prepayments and other current assets
Other assets
Accounts payable and accrued liabilities
Income taxes payable
CASH FLOW FROM OPERATIONS
2001
2002
2003
2004
2005
2006
114.22%
0.00%
0.00%
40.80%
14.64%
0.00%
0.00%
-0.49%
0.00%
-46.38%
-2.98%
-2.47%
-3.70%
-9.32%
-4.33%
100.00%
52.56%
0.00%
0.00%
18.66%
3.03%
2.45%
0.00%
0.55%
0.00%
-10.92%
-0.37%
0.60%
-0.37%
33.81%
0.00%
100.00%
82.00%
0.00%
0.00%
29.26%
-0.44%
2.26%
0.00%
1.29%
0.00%
-29.07%
2.14%
-6.98%
-1.30%
20.62%
0.22%
100.00%
68.50%
0.00%
0.00%
27.10%
-0.40%
1.19%
0.00%
1.15%
0.00%
-33.40%
-0.35%
4.43%
0.39%
32.30%
-0.18%
100.00%
72.66%
0.00%
0.00%
38.33%
-5.44%
1.24%
0.00%
1.10%
0.00%
-36.97%
0.44%
-2.62%
-3.89%
33.73%
1.43%
100.00%
43.26%
0.00%
0.00%
29.85%
-9.15%
1.76%
0.00%
1.24%
0.00%
11.74%
-0.53%
-0.91%
0.44%
23.25%
-0.95%
100.00%
130
Forecasted Statement of Cash Flow with Capital Lease Adjustments
Cash Flows
With Lease Adjustments
Actual Financial Statements
2001 2002 2003 2004
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization
Deferred income taxes
Stock-based compensation expense, including
tax benefits
Loss on disposition of property and equipment
Changes in operating assets and liabilities:
Merchandise inventories
Income tax refund receivable
Prepayments and other current assets
Other assets
Accounts payable and accrued liabilities
Income taxes payable
CASH FLOW FROM OPERATIONS
Cash Flow From Investing
Cash Flow From Financing
Forecast Financial Statements
2005
2006
Assume
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
$189,505 $216,929 $247,475 $257,904 $217,509 $195,111
67,685 $77,015
24,281 $12,499
0 $10,123
$88,315
($1,325)
$6,815
102,010
(1,496)
4,476
(809)
$2,287
$3,905
4,311
(76,946)
(4,936)
(4,094)
(6,144)
(15,455)
(7,177)
165,910
(160,170)
(27,545)
($45,071)
($1,533)
$2,478
($1,542)
$139,541
$0
$412,726
($184,040)
($30,147)
114,733 134,637 31.13% $153,486 $174,974 $199,471 $227,397 $259,232 $295,525 $336,898 $384,064 $437,833 $499,129
(16,279) (41,274)
3,700 7,931
3,306
5,603
($87,739) (125,754) (110,667) 52,932
$6,469 (1,304) 1,304 (2,397)
($21,069) 16,685 (7,842) (4,113)
($3,937) 1,480 (11,658) 1,968
$62,233 121,608 100,974 104,867
$671
(671) 4,272 (4,272)
$301,813 376,477 299,352 450,993
($218,727) ($216,585) ($139,755) ($293,348)
($96,621) ($216,408) ($141,445) ($236,909)
$ 493,049 $ 562,076 $ 640,767 $ 730,474 $ 832,740 $ 949,324 $ 1,082,229 $ 1,233,741 $ 1,406,465 $ 1,603,370
($132,421) ($235,691) ($260,250) ($287,368) ($317,312) ($350,375) ($386,885) ($427,198) ($471,712) ($520,864)
-132 -236 -260
-287
-317
-350
-387
-427
-472
-521
131
3 Month
Time Period
(months)
72
60
48
36
24
Adjusted
R²
Est. Beta ke
10.46%
0.75
10.12%
6.76%
0.84
10.84%
5.13%
0.98
11.94%
4.48%
1.00
12.11%
7.86%
1.26
14.13%
72
60
48
36
24
Adjusted
R²
Est. Beta ke
10.50%
0.75
10.12%
6.84%
0.84
10.86%
5.24%
0.99
11.99%
4.56%
1.01
12.15%
7.93%
1.26
14.15%
72
60
48
36
24
Adjusted
R²
Est. Beta ke
10.52%
0.75
10.11%
6.93%
0.85
10.89%
5.41%
1.00
12.07%
4.67%
1.01
12.19%
7.97%
1.26
14.15%
72
60
48
36
24
Adjusted
R²
10.53%
7.01%
5.69%
4.75%
8.06%
72
60
48
36
24
Adjusted
R²
Est. Beta ke
10.52%
0.75
10.10%
7.02%
0.85
10.94%
5.78%
1.02
12.26%
4.77%
1.02
12.25%
8.08%
1.27
14.20%
1 Year
Time Period
(months)
2 Year
Time Period
(months)
5 Year
Time Period
(months)
7 Year
Time Period
(months)
Est. Beta
0.75
0.85
1.01
1.02
1.26
ke
10.11%
10.93%
12.22%
12.24%
14.19%
132
3 Month
Time Period
Adjusted Est.
(months)
R²
Beta ke
72
10.46%
0.75 10.12%
60
6.76%
0.84 10.84%
48
5.13%
0.98 11.94%
36
4.48%
1.00 12.11%
24
7.86%
1.26 14.13%
Published Beta
Risk-Free Rate
1.01
.0420
SUMMARY OUTPUT
Regression Statistics
0.342350394
Multiple R
R Square
0.117203793
Adjusted R Square
0.104592418
Standard Error
0.071967368
Observations
72
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
70
71
SS
0.048133837
0.362551144
0.410684981
MS
F
Significance F
0.048133837 9.293498782 0.003244149
0.005179302
Coefficients
Standard Error
t Stat
P-value
-0.000182628
0.008527919 -0.021415306 0.982975291
0.748887493
0.245655761 3.048524033 0.003244149
Upper 95% Lower 95.0% Upper 95.0%
Lower 95%
-0.017191025 0.016825769 -0.017191025 0.016825769
0.258942532 1.238832454 0.258942532 1.238832454
SUMMARY OUTPUT
Regression Statistics
0.288754523
Multiple R
R Square
0.083379174
Adjusted R Square
0.067575367
Standard Error
0.073583182
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
0.028566235
0.314040115
0.34260635
MS
0.028566235
0.005414485
F
Significance F
5.2758916 0.025251804
Coefficients
Standard Error
t Stat
P-value
-0.004847637
0.009864026 -0.491446135 0.62496562
0.839891054
0.365657953 2.296930909 0.025251804
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.024592631 0.014897356 -0.024592631 0.014897356
0.107947142 1.571834966 0.107947142 1.571834966
133
SUMMARY OUTPUT
Regression Statistics
0.267416638
Multiple R
R Square
0.071511658
Adjusted R Square
0.051327129
Standard Error
0.076329308
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
0.020641482
0.268003513
0.288644995
MS
F
Significance F
0.020641482 3.542894535 0.066135672
0.005826163
Coefficients
Standard Error
t Stat
P-value
0.011389479 -1.037298118 0.305019115
-0.011814285
0.980187752
0.520751056 1.882257829 0.066135672
Upper 95% Lower 95.0% Upper 95.0%
Lower 95%
-0.034740118 0.011111547 -0.034740118 0.011111547
-0.06802974 2.028405245 -0.06802974 2.028405245
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.268416537
R Square
0.072047438
Adjusted R Square
0.044754715
Standard Error
0.078860078
Observations
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
MS
F
Significance F
0.016416709 0.016416709 2.639803989 0.113452137
0.211443007 0.006218912
0.227859715
Coefficients
Standard Error
t Stat
P-value
-0.004485035
0.013589072 -0.33004721 0.743389321
1.000869224
0.616015294 1.624747362 0.113452137
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.032101352 0.023131282 -0.032101352 0.023131282
-0.251024468 2.252762916 -0.251024468 2.252762916
SUMMARY OUTPUT
Regression Statistics
0.344423914
Multiple R
R Square
0.118627832
Adjusted R Square
0.078565461
Standard Error
0.07169887
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
F
Significance F
SS
MS
0.0152221
0.0152221 2.961078657 0.099327031
0.113096014 0.005140728
0.128318114
Coefficients Standard Error
t Stat
P-value
0.002521106
0.015424481 0.163448366 0.871657632
1.257190596
0.730594085 1.720778503 0.099327031
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.029467309 0.034509521 -0.029467309 0.034509521
-0.257968793 2.772349985 -0.257968793 2.772349985
134
1 Year
Time Period
(months)
72
60
48
36
24
Adjusted Est.
R²
Beta
ke
10.50%
0.75 10.12%
6.84%
0.84 10.86%
5.24%
0.99 11.99%
4.56%
1.01 12.15%
7.93%
1.26 14.15%
Published Beta
Risk-Free Rate
1.01
.0420
SUMMARY OUTPUT
Regression Statistics
0.342951447
Multiple R
R Square
0.117615695
Adjusted R Square
0.105010205
Standard Error
0.071950576
Observations
72
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
70
71
SS
0.048303
0.362381982
0.410684981
F
Significance F
MS
0.048303 9.330513505 0.003186913
0.005176885
Coefficients
Standard Error
t Stat
P-value
0.008520117 -0.001346238 0.998929687
-1.14701E-05
0.24522938 3.054588926 0.003186913
0.749074948
Upper 95% Lower 95.0% Upper 95.0%
Lower 95%
-0.017004307 0.016981367 -0.017004307 0.016981367
0.259980378 1.238169517 0.259980378 1.238169517
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.290184328
R Square
0.084206944
Adjusted R Square
0.068417409
Standard Error
0.07354995
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
MS
F
Significance F
0.028849834 0.028849834 5.333085596 0.024505536
0.313756516 0.005409595
0.34260635
Coefficients
Standard Error
t Stat
P-value
-0.004694585
0.009838495
-0.477165 0.635037769
0.843031122
0.365051663 2.309347439 0.024505536
Upper 95% Lower 95.0% Upper 95.0%
Lower 95%
-0.024388472 0.014999301 -0.024388472 0.014999301
0.112300833 1.573761412 0.112300833 1.573761412
135
SUMMARY OUTPUT
Regression Statistics
0.269366833
Multiple R
R Square
0.072558491
Adjusted R Square
0.052396719
Standard Error
0.076286267
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
0.020943645
0.26770135
0.288644995
MS
F
Significance F
0.020943645 3.598815171 0.064109163
0.005819595
Coefficients
Standard Error
t Stat
P-value
-0.011624537
0.011352995 -1.023918071 0.311228661
0.986199943
0.519858563 1.897054341 0.064109163
Upper 95% Lower 95.0% Upper 95.0%
Lower 95%
-0.034476931 0.011227857 -0.034476931 0.011227857
-0.060221054 2.03262094 -0.060221054
2.03262094
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.270003366
R Square
0.072901817
Adjusted R Square
0.045634224
Standard Error
0.078823766
Observations
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
0.016611387
0.211248328
0.227859715
MS
0.016611387
0.006213186
F
Significance F
2.6735699 0.111253082
Coefficients Standard Error
t Stat
P-value
-0.00434233
0.013555893 -0.320327849 0.750680235
1.005774158
0.615112711 1.635105471 0.111253082
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.03189122 0.02320656 -0.03189122
0.02320656
-0.244285264 2.255833581 -0.244285264 2.255833581
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.345454755
R Square
0.119338988
Adjusted R Square
0.079308942
Standard Error
0.071669938
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
SS
MS
F
Significance F
0.015313354 0.015313354 2.981235342 0.098252418
0.11300476 0.00513658
0.128318114
Coefficients Standard Error
t Stat
P-value
0.002603413
0.015398732 0.169066727 0.867289009
1.25993785
0.729711167 1.72662542 0.098252418
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.029331603 0.034538429 -0.029331603 0.034538429
-0.253390479 2.773266178 -0.253390479 2.773266178
136
2 Year
Time Period
(months)
72
60
48
36
24
Adjusted Est.
R²
Beta
ke
10.52%
0.75 10.11%
6.93%
0.85 10.89%
5.41%
1.00 12.07%
4.67%
1.01 12.19%
7.97%
1.26 14.15%
Published Beta
Risk-Free Rate
1.01
.0420
SUMMARY OUTPUT
Regression Statistics
0.343264596
Multiple R
R Square
0.117830583
Adjusted R Square
0.105228162
Standard Error
0.071941815
Observations
72
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
70
71
SS
MS
F
Significance F
0.048391251 0.048391251 9.349837596 0.003157452
0.362293731 0.005175625
0.410684981
t Stat
P-value
Coefficients Standard Error
0.000166024
0.008513542 0.019501171 0.984496783
0.748271382
0.244713034 3.057750414 0.003157452
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.0168137 0.017145748
-0.0168137 0.017145748
0.260206631 1.236336134 0.260206631 1.236336134
SUMMARY OUTPUT
Regression Statistics
0.291736457
Multiple R
R Square
0.08511016
Adjusted R Square
0.069336198
Standard Error
0.073513671
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
0.029159281
0.313447068
0.34260635
MS
F
Significance F
0.029159281 5.395610589 0.023716574
0.00540426
Coefficients
Standard Error
t Stat
P-value
-0.004585286
0.00981791 -0.467032843 0.642226155
0.847133396
0.364696423 2.322845365 0.023716574
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.024237968 0.015067395 -0.024237968 0.015067395
0.117114195 1.577152596 0.117114195 1.577152596
137
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.272466245
R Square
0.074237855
Adjusted R Square
0.054112591
Standard Error
0.076217168
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
0.021428385
0.26721661
0.288644995
MS
0.021428385
0.005809057
F
Significance F
3.6887891 0.060990766
Standard Error
t Stat
P-value
Coefficients
-0.011550665
0.011325888 -1.019846282 0.313135315
0.99654207
0.518864221 1.920622061 0.060990766
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.034348495 0.011247165 -0.034348495 0.011247165
-0.047877421 2.04096156 -0.047877421
2.04096156
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.271883196
R Square
0.073920472
Adjusted R Square
0.046682839
0.07878045
Standard Error
Observations
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
0.016843498
0.211016218
0.227859715
MS
F
Significance F
0.016843498 2.713909533
0.10868973
0.006206359
Coefficients
Standard Error
t Stat
P-value
-0.004352053
0.013544214 -0.321321914 0.749933462
1.01135428
0.613911309 1.647394772 0.10868973
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.031877206 0.023173101 -0.031877206 0.023173101
-0.236263599 2.258972159 -0.236263599 2.258972159
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.345988185
R Square
0.119707824
Adjusted R Square
0.079694544
Standard Error
0.071654928
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
SS
MS
F
Significance F
0.015360682 0.015360682 2.991702314 0.097699737
0.112957431 0.005134429
0.128318114
Coefficients Standard Error
t Stat
P-value
0.002485745
0.015414535 0.161259813 0.873360508
1.25973938
0.728318794 1.729653813 0.097699737
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.029482044 0.034453534 -0.029482044 0.034453534
-0.250701345 2.770180105 -0.250701345 2.770180105
5 Year
138
Time Period
(months)
72
60
48
36
24
Adjusted
R²
10.53%
7.01%
5.69%
4.75%
8.06%
Est.
Beta
0.75
0.85
1.01
1.02
1.26
ke
10.11%
10.93%
12.22%
12.24%
14.19%
Published Beta
Risk-Free Rate
1.01
.0420
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.343411581
R Square
0.117931514
Adjusted R Square
0.105330536
Standard Error
0.071937699
Observations
72
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
70
71
SS
MS
F
Significance F
0.048432702 0.048432702 9.358917282 0.003143707
0.362252279 0.005175033
0.410684981
Coefficients Standard Error
t Stat
P-value
0.000578759
0.008501851 0.06807442 0.945920471
0.747883101
0.244467379 3.059234754 0.003143707
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.016377647 0.017535165 -0.016377647 0.017535165
0.260308295 1.235457907 0.260308295 1.235457907
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.293049875
R Square
0.085878229
Adjusted R Square
0.070117509
0.073482806
Standard Error
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
0.029422427
0.313183923
0.34260635
MS
F
Significance F
0.029422427 5.448877231 0.023065815
0.005399723
Coefficients
Standard Error
t Stat
P-value
-0.004228187
0.00977302 -0.432638693 0.66688176
0.852179401
0.365071156 2.334283023 0.023065815
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.023791012 0.015334639 -0.023791012 0.015334639
0.121410091 1.58294871 0.121410091
1.58294871
139
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.277461107
R Square
0.076984666
Adjusted R Square
0.056919115
Standard Error
0.076104013
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
0.022221239
0.266423756
0.288644995
MS
F
Significance F
0.022221239 3.836658508 0.056222052
0.005791821
Coefficients Standard Error
t Stat
P-value
-0.01132603
0.011271403 -1.004846556 0.320227487
1.014801849
0.518089364
1.95873901 0.056222052
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.034014186 0.011362126 -0.034014186 0.011362126
-0.028057936 2.057661634 -0.028057936 2.057661634
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.273388185
R Square
0.0747411
Adjusted R Square
0.047527602
Standard Error
0.078745538
Observations
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
0.017030486
0.21082923
0.227859715
F
Significance F
MS
0.017030486 2.746471698
0.10666988
0.00620086
Coefficients Standard Error
t Stat
P-value
-0.00430355
0.01352662 -0.318154138 0.752314045
1.017270748
0.613831247 1.657248231 0.10666988
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.031792949 0.023185849 -0.031792949 0.023185849
-0.230184426 2.264725923 -0.230184426 2.264725923
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.347274626
R Square
0.120599666
Adjusted R Square
0.080626924
Standard Error
0.071618621
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
SS
MS
F
Significance F
0.015475122 0.015475122 3.017047583 0.096376376
0.112842992 0.005129227
0.128318114
Coefficients Standard Error
t Stat
P-value
0.002416109
0.015413707 0.156750694 0.876870949
1.264380047
0.727924864 1.736965049 0.096376376
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.029549962 0.034382181 -0.029549962 0.034382181
-0.245243716 2.77400381 -0.245243716
2.77400381
140
7 Year
Time Period
(months)
72
60
48
36
24
Adjusted Est.
R²
Beta
ke
10.52%
0.75 10.10%
7.02%
0.85 10.94%
5.78%
1.02 12.26%
4.77%
1.02 12.25%
8.08%
1.27 14.20%
Published Beta
Risk-Free Rate
1.01
.0420
SUMMARY OUTPUT
Regression Statistics
0.343265646
Multiple R
R Square
0.117831304
Adjusted R Square
0.105228894
Standard Error
0.071941785
Observations
72
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
70
71
F
Significance F
SS
MS
0.048391547 0.048391547 9.349902461 0.003157353
0.362293434 0.00517562
0.410684981
Coefficients Standard Error
t Stat
P-value
0.000760481
0.008498104 0.089488367 0.92894935
0.747430186
0.244437083 3.057761021 0.003157353
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.016188453 0.017709416 -0.016188453 0.017709416
0.259915801 1.23494457 0.259915801
1.23494457
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.293232465
R Square
0.085985279
Adjusted R Square
0.070226404
0.073478503
Standard Error
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
0.029459102
0.313147247
0.34260635
MS
F
Significance F
0.029459102 5.456308358 0.022976555
0.00539909
Coefficients
Standard Error
t Stat
P-value
-0.004051424
0.009754198 -0.415351805 0.679416979
0.853179364
0.365250559 2.335874217 0.022976555
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.023576571 0.015473724 -0.023576571 0.015473724
0.12205094 1.584307789
0.12205094 1.584307789
141
SUMMARY OUTPUT
Regression Statistics
0.278963662
Multiple R
R Square
0.077820725
Adjusted R Square
0.057773349
0.076069538
Standard Error
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
0.022462563
0.266182432
0.288644995
MS
F
Significance F
0.022462563 3.881841013 0.054847791
0.005786575
Coefficients
Standard Error
t Stat
P-value
-0.011200325
0.011249202 -0.995655066 0.324626613
0.517894017 1.970238821 0.054847791
1.020374898
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.033843794 0.011443144 -0.033843794 0.011443144
-0.022091674 2.06284147 -0.022091674
2.06284147
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.273698762
R Square
0.074911012
Adjusted R Square
0.047702513
0.078738307
Standard Error
Observations
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
0.017069202
0.210790513
0.227859715
MS
F
Significance F
0.017069202 2.753220992 0.106256613
0.006199721
Coefficients
Standard Error
t Stat
P-value
-0.004244581
0.013515929 -0.314042862 0.755407339
1.018771379
0.613982792 1.659283277 0.106256613
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.031712252 0.023223091 -0.031712252 0.023223091
-0.228991772 2.26653453 -0.228991772
2.26653453
SUMMARY OUTPUT
Regression Statistics
0.347567662
Multiple R
R Square
0.12080328
Adjusted R Square
0.080839793
Standard Error
0.07161033
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
F
Significance F
SS
MS
0.015501249 0.015501249 3.022841301 0.096076803
0.112816865 0.005128039
0.128318114
Coefficients Standard Error
t Stat
P-value
0.002433163
0.015407514 0.157920512 0.87595997
1.265702648
0.727987655 1.73863202 0.096076803
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.029520066 0.034386391 -0.029520066 0.034386391
-0.244051337 2.775456633 -0.244051337 2.775456633
142
Discounted Dividends Approach
WACC(BT)
Earnings
Dividends
Book Value of Equity
Cash From Operations
Cash Investments
PV Factor
PV Dividends Year by Year
Total PV of Annual Dividends
Continuing (Terminal) Value Perpetuity
PV of Terminal Value Perpetuity
Estimated Price per Share (end of 2006)
Implied Nov. 4, 2007 Share Price
Observed Share Price
Initial Cost of Equity (You Derive)
Perpetuity Growth Rate (g)
Kd
0.04724
Ke
0.1011
0
1
2
3
4
5
6
7
8
9
10
2006
2007
320574
76930
2008
353978
84946
2009
390863
93797
2010
431591
103571
2011
476562
114363
2012
526220
126280
2013
581052
139438
2014
641598
153968
2015
708452
170011
2016
782273
187726
493
113
562
127
640
140
730
155
832
171
949
189
1082
208
1233
230
1406
254
1603
280
0.908
69866
32%
0.825
70063
0.749
70260
0.680
70458
0.618
70657
0.561
70856
0.510
71055
0.463
71255
0.420
71456
0.382
71657
1208393
$ 707,582.83
$
$
$
$
0.0848
1,472,400
15.52
16.82
23.24
10.11%
5%
68%
100%
g
0.06
ke 0.08
0.09
0.1011
0.12
0.14
Perp
11
197113
$3,857,390
0
$19.62
$14.24
$12.47
$10.93
$8.99
$7.53
0.03
$33.46
$19.58
$16.14
$13.47
$10.46
$8.43
0.05
$88.82
$29.09
$21.65
$16.82
$12.14
$9.35
<19.24
0.07
N/A
$76.61
$38.18
$24.48
$15.17
$10.81
0.1
N/A
N/A
N/A
$558.20
$31.05
$15.72
>27.24
Fairly Valued within 20% of $23.24
Discounted Free Cash Flows
Family Dollar
2006
Cash Flow from Operations
Cash Provided (Used) by Investing Activities
Free Cash Flow (to firm)
PV factor (discount rate 8.48% WACC)
Present Value of Free Cash Flows
Total Present Value of Annual Cash Flows
Continuing (Terminal) Value (assume no growth)
Present Value of Continuing (Terminal) Value
Value of the Firm (end of 2006)
Book Value of Debt and Preferred Stock
Value of Equity (end of 2006)
Estimated Value per Share Nov. 4, 2007
Earnings Per Share
Dividends per share
Book Value Equity Per Share
Actual Price per share
2007
493
-113
2008
562
-127
2009
640
-140
2010
730
-155
2011
832
-171
2012
949
-189
2013
1082
-208
2014
1233
-230
2015
1406
-254
2016 P
1603
-280
380
0.922
350.3
435
0.850
369.6
500
0.783
391.7
575
0.722
415.2
661
0.666
440.0
760
0.614
466.4
874
0.566
494.4
1,003
0.521
523.0
1,152
0.481
553.7
1,323
0.443
586.2
4,591
16509.43
7,315
11,906
1,315
10,591
70.23
Sensitivity Analysis
3102.7
WACC
2.28
0.584
$8.60
$23.24
0.07
0.0848
0.09
0.1
0.11
g
0
0.01
0.03
$91.76 $103.00 $142.33
$70.23 $76.71 $96.78
$64.44 $69.88 $86.22
$55.11
$59.08 $70.45
$47.60 $50.57 $58.74
< 19.24 overvalued
0.05
$260.31
$139.92
$118.90
$90.90
$72.37
> 27.24 undervalued
Fairly valued
143
1400
RESIDUAL INCOME
WACC(AT)
0
2006
Earnings
Dividends
Book Value of Equity
Cash From Operations
Cash Investments
Actual Earnings
"Normal" (Benchmark) Earnings
Residual Income (Annual)
PV Factor
PV of Annual Residual Income
Total PV of Annual Residual Income
Continuing (Terminal) Value Perpetuity
PV of Terminal Value Perpetuity
Initial Book Value of Equity
Book Value of Liabilities
Estimated Price per Share (end of 1987)
Time consistant implied price(11/01/2007)
Observed Share Price
Initial Cost of Equity (You Derive)
Perpetuity Growth Rate (g)
1208393
1472825.59
0.0795
1
2007
320574
76930
1452037
493
113
320574
122169
198406
0.908
180189
Kd
2
2008
353978
84946
1721069
562
127
353978
146801
207177
0.825
170879
3
2009
390863
93797
2018135
640
140
390863
174000
216863
0.749
162444
0.04724
4
2010
431591
103571
2346154
730
155
431591
204033
227557
0.680
154804
5
2011
476562
114363
2708353
832
171
476562
237196
239366
0.618
147887
Ke
6
2012
526220
126280
3108293
949
189
526220
273814
252406
0.561
141624
0.1011
7
2013
581052
139438
3549907
1082
208
581052
314248
266804
0.510
135958
8
2014
641598
153968
4037537
1233
230
641598
358896
282702
0.463
130832
9
2015
708452
170011
4575978
1406
254
708452
408195
300257
0.420
126198
g
1417818.62
1208393
ke
0.08
0.09
0.1011
0.12
0.13
0.14
29.18
31.62
$23.14
0.1011
0
10
11
2016
P
782273
187726
5170525
1603
280
782273
462631
319642 341046
0.382
122010
3373351
0
44.93
37.76
31.62
24.06
21.07
18.58
-0.1
33.40
29.69
26.18
21.33
19.23
17.39
-0.2
30.10
27.19
24.35
20.31
18.51
16.91
-0.3
28.54
25.97
23.44
19.78
18.13
16.64
-0.4
27.63
25.25
22.89
19.45
17.89
16.47
-0.5
27.03
24.77
22.52
19.23
17.72
16.36
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of $23.14
AEG VALUATION
2006
Earnings
Dividends
DPS invested at 10.11% (DRIP)
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth (AEG)
PV Factor
PV of AEG
R.I. check figures
Core Earnings
Total Pv of annual AEG
Continuing (Terminal) Value
PV of Terminal Value
Total PV of total AEG
Total Average Earnings Perp (t+1)
Capitalization Rate (Ke)
Intrinsic Value Per Share (end of 2006)
Time Consistent Implied Price
Nov 1, 2007 Observed Price
Ke
g
Actual Price per Share
WACC(AT)
0.0795
Kd
0
1
2007
320574
76930
2008
353978
84946
7778
361756
352984
8771.399
0.908
7966.03
2009
2010
390863
431591
93797
103571
8588
9483
399451
441073
389765
430379
9685.378 10694.595
0.825
0.749
7988.46
8010.95
8771.399
9685.378 10694.595 11808.972 13039.467 14398.179 15898.469 17555.090
2
0.04724
3
Ke
0.1011
4
5
6
7
8
Forecast Years
2011
2012
2013
2014
2015
476562
526220
581052
641598
708452
114363
126280
139438
153968
170011
10471
11562
12767
14097
15566
487033
537782
593819
655695
724018
475224
524743
579421
639797
706463
11808.972 13039.467 14398.179 15898.469 17555.090
0.680
0.618
0.561
0.510
0.463
8033.50
8056.12
8078.80
8101.55
8124.36
9
2016
782273
187726
17188
799461
780077
19384.330 21404.177
0.420
8147.23
19384.330
195111.00
72507.00
$ 211,712.93
88982.89
161489.90
356600.90
10.11%
$
$
$
25.11
27.21
23.24
10.11%
0
$23.24
19.24
Sensitivity Analysis
g
Ke
0.08
0.09
0.1011
0.12
0.14
0
50.69
37.24
27.20
16.78
10.57
-0.1
39.50
30.84
23.83
15.87
10.66
-0.2
36.30
28.85
22.69
15.53
10.70
-0.3
34.79
27.88
22.13
15.35
10.72
Perp
-0.4
33.91
27.30
21.79
15.24
10.73
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of $23.24
144
Long Run ROE Residual Income Model
g
ke
0.12
N/A
N/A
N/A
14.28
4.76
0.06
0.08
0.1011
0.13
0.15
ke
0.06
0.08
0.1011
0.13
0.15
0.14
0.37
0.49
0.75
2.92
N/A
0.16
2.01
2.52
3.42
6.71
20.13
0.18
3.11
3.73
4.73
7.47
12.44
0.2
3.9
4.54
5.51
7.79
10.91
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of
$23.24
ROE
0.09
0.12
0.1366
0.16
0.18
12.9
17.2
19.58
22.94
25.81
9.68
12.9
14.69
17.2
19.36
7.66
10.21
11.62
13.61
15.32
5.96
7.94
9.04
10.59
11.91
5.16
6.88
7.84
9.18
10.32
< 19.24 overvalued
> 27.24 undervalued
Fairly valued within 20% of
$23.24
g
ROE
0.09
0.12
0.1366
0.16
0.18
0.12
13.65
N/A
N/A
N/A
0.14
11.06
4.42
0.75
N/A
N/A
0.16
10.22
5.84
3.42
N/A
0.18
9.81
6.54
4.73
2.18
0.2
9.57
6.96
5.51
3.48
1.74
145
< 19.24 overvalued
> 27.24 undervalued
Z - Score Analyisis
Fairly valued within 20% of $23.24
1.2 x
Z-Score =
Working Capital
Total Assets
+
2002
525,079
1,754,619
2003
561,161
1,985,695
2004
489,727
2,224,361
2005
460,157
2,409,501
2006
432,737
2,523,029
1.4 x
Retained Earnings
Total Assets
+
1,118,015
1,754,619
1,315,600
1,985,695
1,498,890
2,224,361
1,654,861
2,409,501
1,546,366
2,523,029
3.3 x
EBIT
Total Assets
+
341,621
1,754,619
389,725
1,985,695
403,362
2,224,361
338,810
2,409,501
317,305
2,523,029
0.6 x
Market Value of Equity
Book Value of Liabilities
+
4,933,440
599,671
6,914,522
674,726
4,516,867
887,279
3,315,805
981,435
3,856,161
1,314,636
1.0 x
Sales
Total Assets
4,162,652
1,754,619
4,750,171
1,985,695
5,281,888
2,224,361
5,824,808
2,409,501
6,394,772
2,523,029
2002
RAW
Z-Score
2004
2005
2006
0.2993
0.2826
0.2202
0.1910
0.1715
0.6372
0.6625
0.6739
0.6868
0.6129
0.1947
0.1963
0.1813
0.1406
0.1258
8.2269
10.2479
5.0907
3.3785
2.9333
2.3724
2.3922
2.3746
2.4174
2.5346
2002
Weighted
2003
2003
2004
2005
2006
0.3591
0.3391
0.2642
0.2292
0.2058
0.8921
0.9276
0.9434
0.9615
0.8581
0.6425
0.6477
0.5984
0.4640
0.4150
4.9361
6.1487
3.0544
2.0271
1.7600
2.3724
2.3922
2.3746
2.4174
2.5346
9.2022
10.4553
7.2350
6.0993
5.7734
146
(Revised) Z - Score Analyisis
1.2 x
Z-Score =
Working Capital
Total Assets
+
2002
2003
2004
2005
2006
525,079
561,161
489,727
460,157
432,737
2,336,309 2,664,037 3,044,573 3,369,833 3,548,335
1.4 x
Retained Earnings
Total Assets
+
1,118,015
2,336,309
1,315,600
2,664,037
1,498,890
3,044,573
1,654,861
3,369,833
1,546,366
3,548,335
3.3 x
EBIT
Total Assets
+
372,625
2,336,309
425,881
2,664,037
447,079
3,044,573
389,996
3,369,833
371,954
3,548,335
0.6 x
Market Value of Equity
Book Value of Liabilities
+
4,933,440
1,181,361
6,914,522
1,353,068
4,516,867
1,707,491
3,315,805
1,941,767
3,856,161
2,339,942
1.0 x
Sales
Total Assets
4,162,652
2,336,309
4,750,171
2,664,037
5,281,888
3,044,573
5,824,808
3,369,833
6,394,772
3,548,335
2002
RAW
Z-Score
2004
2005
2006
0.2247
0.2106
0.1609
0.1366
0.1220
0.4785
0.4938
0.4923
0.4911
0.4358
0.1595
0.1599
0.1468
0.1157
0.1048
4.1761
5.1103
2.6453
1.7076
1.6480
1.7817
1.7831
1.7349
1.7285
1.8022
2002
Weighted
2003
2003
2004
2005
2006
0.2697
0.2528
0.1930
0.1639
0.1463
0.6700
0.6914
0.6892
0.6875
0.6101
0.5263
0.5275
0.4846
0.3819
0.3459
2.5056
3.0662
1.5872
1.0246
0.9888
1.7817
1.7831
1.7349
1.7285
1.8022
5.7533
6.3209
4.6889
3.9864
3.8934
147
References
1.
Family Dollar’s website www.familydollar.com
2006 10K Annual Report
2001 10K - 2007 10K
2.
Dollar Tree’s website www.dollartree.com
2006 10K Annual Report
2001 10K – 2007 10K
3.
99 Cent Only Store’s website www.99only.com
2006 Annual Report
2001 10K – 2007 10K
4.
Dollar General’s website www.dollargeneral.com
2006 Annual Report
2001 10K – 2007 10K
5.
QuickMBA
6.
WIKIPEDIA www.wikipedia.com
7.
Reuters www.reuters.com
8.
Answers www.answers.com
9.
Hoovers
www.quickmba.com
www.hoovers.com
10. Investopedia
www.investopedia.com
11. Business Analysis & Valuation by Palepu & Healy
12. WiseGeek
www.wisegeek.com
13. Yahoo! Finance www.finance.yahoo.com
14. NYU Stern
www.stern.nyu.edu
15. St. Louis Fed FRED date
http://research.stlouisfed.org/fred2/
148