How to Turn $1 Into $1.6 Billion

Dollar stores' stock rivals their wares for great value

   

Fifteen years ago, I walked into a 99 Cents Only store. Being an unemployed graduate student, I was eager to save as much money as I could while buying the things one needs to live one’s life. I discovered that you get what you pay for. After loading up on dish soap, paper towels and other staples, I found the quality to be absolute garbage. I vowed never to waste my time or money again.
But a few years ago, I sauntered into a Dollar Tree (NASDAQ:DLTR) because the stock had been doing well and I couldn’t fathom why that was the case. How could there by tens of thousands of these dollar stores when all they sold was junk? As it turns out, they didn’t sell junk anymore. They sold brand-name merchandise. I became a fan.

Evidently, so has the world of private equity and hedge funds. They’ve taken notice of these stores’ great margins, increasing market share and growing earnings (some at 20% annually). I thought it was amazing when hedge fund manager Bill Ackman purchased a ton of stock in Family Dollar (NYSE:FDO). Warren Buffett also took a stake in Dollar General (NYSE:DG). These, however, are nothing compared to the $1.6 billion private buyout of 99 Cents Only Stores that recently just closed. What does this tell us about the present valuations of the dollar stores — and whether any of them are buys?
The $1.6 billion price tag for 99 Cents Only was 21.6 times 2011 earnings of $74 million, and 1.1 times sales. Dollar Tree’s trailing 12-month earnings are $463 million, so a 21.6 multiple puts its present value right at $10 billion, or exactly what DLTR trades at today, although that is 1.5 times sales.
Family Dollar has $394 million in TTM earnings, and giving it a 21.6 multiple yields $8.5 billion, which is 1 times sales. With only $250 million in net debt, that suggests Family Dollar — presently trading at a market cap of $6.46 billion — might be undervalued by as much as 30%. With the stock trading at $55, it suggests the stock might be worth closer to $70. Perhaps Mr. Ackman is on to something here.
Dollar General is the big kahuna, with TTM net income of $698 million. That 21.6 multiple would make it worth a whopping $15.08 billion, also representing about 1.07 times sales. The present market cap is $14.04 billion, suggesting a modest premium of 7% exists, which might make the stock worth $44. But hang on — DG carries $2.6 billion in net debt, so that wipes out that premium and then some.
Strictly examining the stores on the basis of the buyout, then, it appears Family Dollar is drastically undervalued. It certainly has room for improvement operationally, and Mr. Ackman is known for finding companies that could use fresh eyes and a different approach. I think if you put your faith in Mr. Ackman, you won’t be disappointed.
I’ve always liked Dollar Tree because of its consistency, however, so given its expected 20% earnings growth, it’s likely you won’t go wrong there, either.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned stocks
Jan 23, 2012, 12:53 pm EST   |   By Lawrence Meyers, InvestorPlace Contributor