Big Growth Plans for Target and Family Dollar (WMT, TGT, CSTR, FDO)

By: Chad Fraser

The 18 retailers tracked by Thomson Reuters showed surprising strength in May, with same-store sales rising by an average of 3.9% from May 2011, exceeding the 3.6% that analysts were expecting. The result was particularly surprising in light of a weaker performance in April.

Lower gas prices helped these retail stocks post strong sales gains, as did the fact that Mother’s Day fell in the middle of the month instead of toward the beginning.

Still, shoppers look like they’re continuing to dig into their wallets in June. According to Redbook Research, U.S. chain store sales rose 1.1% in the first week of June from May, beating the expected 0.9% increase.

Consumer spending accounts for about 70% of all U.S. economic activity, so more trips to the mall would obviously bring an across-the-board shot in the arm. For investors, now could be a great time to buy some high-quality retail stocks. Here are two to consider.

Family Dollar Is One of the Year’s Best-Performing Retail Stocks

Shares of Family Dollar FDO have performed well so far in 2012, rising 15.8% in the first five months. The company is the nation’s second-largest dollar-store chain, with 7,200 outlets in 45 states.

As I wrote in “How Family Dollar Thrives in a Tough Economy,” investors have often seen the stock as a defensive play during tough times, the thinking being that when money is scarce, cash-strapped consumers flock to the dollar store for their everyday needs in search of bargains.

That’s what powered Family Dollar to a stellar performance in 2008: The shares rose 38.6% that year—the best performance of the S&P 500—while the broader index plunged 38.0%.

Making the Leap Beyond Dollar Stores

Lately, the company has been making moves to expand beyond the dollar-store space in a bid to attract a less price-conscious consumer. For example, it is now adding popular brands of discretionary products, like Red Bull energy drinks and Maybelline cosmetics, to its lineup.

In addition, Family Dollar announced this week that it has signed an agreement with Coinstar CSTR to carry Coinstar’s Redbox DVD and video-game rental kiosks in its stores. The move is part of the company’s plan to offer more products to encourage repeat visits. To that end, it is also expanding its offerings of items like food, magazines and tobacco products.

Another area where Family Dollar doesn’t skimp is on rewarding its shareholders. The retail stock’s dividend has risen every year since it started its payout in 1974. The current quarterly rate of $0.21 yields 1.24% on an annualized basis.

Family Dollar also regularly buys back its stock. During the first half of its 2012 fiscal year, which ended February 25, it spent $72.1 million to repurchase 1.3 million shares. It has a high $515.2 million remaining on its current authorizations.

Target Stood Out From Other Retail Stocks in May

Target TGT is one of the retailers that Thomson Reuters surveys to take the monthly temperature of the retail sector. In May, the company saw a 4.4% jump in same-store sales, well ahead of the average.

Target is the country’s second-biggest retailer, behind Wal-Mart WMT. The company operates nearly 1,770 stores in 49 states. The shares have also had a strong start to the year, rising 12.5% through the first five months.

Target recently reported better-than-expected quarterly results and raised its guidance for the full year.

In the first quarter, Target’s sales rose 5.9%, to $16.87 billion from $15.94 billion a year ago. Earnings rose 1.2%, to $697 million, or $1.04 a share. Both figures beat the Street’s expectation of $1.02 in earnings on $16.83 billion of revenue. During the quarter, the company spent $55 million, or $0.09 a share, getting ready for its upcoming foray into Canada (see below).

Due to the better-than-expected results, Target raised its full-year earnings guidance by $0.05. It now expects earnings per share of $4.60 to $4.80 on the year, ahead of the $4.28 a share that analysts were expecting.

Target Takes a Smart Approach to International Expansion

Target is now looking to build on its strength in the U.S. by expanding overseas. Many U.S. retailers, most notably Wal-Mart, have flourished in international markets, particularly in rapidly developing countries like Brazil and China. Still, many foreign markets are highly competitive, and it’s often hard to predict how consumers will react to the presence of a new U.S. chain.

To mitigate the risk of expanding overseas, Target is starting small and close to home, with plans to open 100 to 150 stores in Canada in 2013 and 2014. These stores will come from the 220 locations operated by Canadian retailer Zellers that Target bought for $1.825 billion in January 2011.

Buying stores from an established chain is a smart strategy for Target, because customers are already accustomed to coming to these locations on a routine basis.

The company expects its earnings from the new stores to be similar to what it makes from new outlets in the United States. 

Article originally posted here.