Wednesday, October 15, 2008
(Cont'd from above)...

There are probably no more than 100 stocks right now using that criteria. Although, as we get industrial stocks going to a 6% yield, we get more and more prospects with each down day. Remember, another thing on Mad Money that we've learned is that, as stocks go down, they get cheaper.

As far as companies that thrive in a recession, yesterday, we talked about pawn shops as a play on half the country moving into the poor house, courtesy of the severe, impending recession.

Today, I want to talk about another one like that... another tradedown play... the one kind of retailer you can bank on, when retail sales are falling through the floor... dollar stores.

When your 401k has just taken a huge haircut, if not a beheading... when you're worried about losing your home and losing your paycheck, you don't shop at Macy's... you go to the dollar store.

In this economy, people who would have been scandalized to go into one these places a few months ago, will be shopping at them en masse. I've got one a couple of blocks away from my beach house and, believe me, I have forgotten Saks Fifth Avenue, alright. I've got FDO...

So which dollar store do we buy?...

We've got two choices. We've got Dollar Tree Stores (DLTR). That's got the best operating metrics, better margins, higher return on invested capital... all that good stuff, right...

Or we've got Family Dollar Stores Inc. (FDO)...

It's the biggest dollar store player, with over 6500 stores, compared to 3500 for DLTR.

Right now, I think FDO is a better value. It's a better stock, even though, on most points, DLTR is the better company.

Why?...

We've got to look at expectations. Wall Street loves DLTR. It just got upgraded by two boutique brokers today. And, of the analysts covering it, 7 rated it a buy, 5 are neutral, and none are saying sell.

The good news is already baked into the DLTR stock. It's too loved...

FDO, on the other hand, is more of a low expectations story... 4 buys, 9 neutrals, 2 sells... so there's greater potential for upgrades and estimate increases, as the economy worsens, and more people start shopping at these extremely bottom-of-the-barrel places. Although, I've got to tell you... as I said in Jim Cramer's Stay Mad For Life, we can't be snobs. Those big New York hotshot analysts... they don't go to Family Dollar. They don't know that it ain't so bad.

We know FDO is the better recession play because, during the last recession, from 2000 to 2002, it did far better than Dollar Tree. Listen to how this stock does in a recession...

FDO was up 38.8% in 2000, 40.6% in 2001, and 7.4% in 2002. These were all years where the S&P was down double digits. Remember, history teaches us something. DLTR fell 29% in 2000, it was up 33% in 2001, and fell 15% in 2002.

So the record is clear... FDO kicked butt the last time around. DLTR? No, they felt it...

Plus, the Street is missing the fact that FDO is currently working through all of these internal efficiencies that DLTR has already executed. For DLTR to grow, it needs to expand, opening up new stores. But for FDO to beat the estimates, it just needs to improve operations.

Remember, on Mad Money, we're in capital preservation mode right now, and the companies should be like FDO... which has already made itself bigger, and is now trying to make itself better, and has the better business model in this environment.

And, even though FDO is the bigger player, it hasn't even opened a single store yet in California. Man, are they getting poor out there. This place is ready. Management thinks it has the potential for a thousand new stores. I think they are being conservative.

This one hasn't saturated the market... not even close. So, how will FDO play catch up?...

First, it's improving the mix of products it sells to shift away from what customers want, and toward what they need... Food sales, for example, have increased from 56% in fiscal year 2004, to 61%...

It's come to the point where people are doing their grocery shopping at Family Dollar stores...

FDO is selling less discretionary junk that people don't want right now, like apparel, home products and electronics. The company made the shift to accept - and this is a good thing - food stamps... man, if this isn't a food stamp economy, what is... if not a bread line economy... and credit cards at half of the 6500 stores by this holiday season. Last year, they only accepted credit cards at 200 stores. This is something Dollar Tree has already done. It really worked well for them. When Dollar Tree began accepting credit cards, the average ticket - how much the customer purchased per trip - increased from $6 to $16.

DLTR has already been through this profitable transition. This is the time to own this thing. You want to own FDO, because people are trading down.

FDO is also improving how it sources its merchandise. Right now, directly, it only sources 5% of its products, and has less than 10% private label - "Family Pantry" - which is more profitable for the store. But the company has a new sourcing program that should let it increase the amount of private label goods it sells, and thus, increase its profitability.

The company beat the Street's consensus estimate, when reported October 3rd, with earnings per share coming in at 38 cents, versus 34 cents consensus. How many companies have beaten the numbers here? I mean, management's guidance was 30-34 cents. This was underpromise, overdeliver.

FDO reported 8% sales growth, 5.6% increase in same-store sales... everyone else is missing, right... a 25% increase in free cash flow. Do you think Jones Apparel (JNY) did that? And a 5-6% decrease in inventory per store, with total inventories down 3.1%.

This is what you want to see in a retailer... higher sales, lower inventories.

Outside of the dollar stores, which are poised to take over the world, given how bad things are, it's hard to find a retailer that's doing both of these things. Let me ask you... do you think, if President Bush went into a dollar store, he would think that everything was $4.95?

FDO has temporarily suspended its buyback... something that may be wise, given that so many companies wasted so much capital propping it up... or, at least, trying to prop up their stocks.

It does not fit our yield category, but we do like tradedown names in a recession, and there are only a handful out there.

FDO is trading at a discount to where it ought to be in troubled times... This one has two reasons to go up...

A better price-to-earnings multiple coming, and it could beat the earnings estimate, which is really one of maybe a thimble of companies where the estimates still matter.

Here's the bottom line...

Jim's comments AFTER the interview:   For the ultimate tradedown play, I need you to buy Family Dollar Stores Inc. (FDO). Hopefully, if you own the stock, you'll actually be able to avoid shopping there.

Read Jim's next Segment here