Executive Summary
Dollar Tree has a better financial performance than Family Dollar. Dollar Tree obtains goods at a slightly lower cost than Family Dollar. Dollar Tree is operating more efficiently than Family Dollar. As a result, Dollar Tree is more profitable than Family Tree. Dollar Tree uses assets more efficiently, which creates more value for shareholders. Dollar Tree reinvests a higher proportion of its earnings, which indicates that it may at a higher rate than Family Dollar. Family Dollar uses a large proportion of long-term debt, which causes it to have higher interest expenses than Dollar Tree. A higher degree of leverage increases risk for an investor. Both firms are above average in many areas compared with industry averages except in dividend yields. Value creation for an investor relies on profitability, growth prospects, and efficiency, all which Dollar Tree has a better performance than Family Dollar. Stock prices are based on the optimism derived from the same factors. Dollar Tree is a better choice for the investor.
Introduction
Dollar Tree provides an investor with a better opportunity to increase their net worth than Family Dollar. The vertical common-size analysis shows that Dollar Tree is run more efficiently than Family Dollar. Family Dollar’s cost of sales is higher than Dollar Tree’s, which may indicate that Dollar Tree has a better relationship with its suppliers. The Horizontal analysis shows that Family Dollar’s efficiency may not be able to catch up with Dollar Tree’s because Family Dollar is becoming less efficient when Dollar Tree is becoming more efficient. Family Dollar is less profitable than Dollar Tree. Dollar Tree’s net sales increases at a higher rate than Family Dollar’s. Both firms use assets in the same level of efficiency. Both firms keep large proportions of inventory, which explains the large difference between the current ratio and quick ratio. Family Dollar uses more leverage than Dollar Tree, which increases risk for an investor. The risk for an investor refers to the reduced possibility of sharing net income, and retaining owner’s equity in case of bankruptcy. The firms’ financial performance is above the industry’s average. They fall under variety stores industry. Dollar Tree provides an investor with a better opportunity because it is more profitable, has less debt, and it is run more efficiently than Family Dollar.
Financial Analysis
Common-size Analysis
Vertical Common-Size Analysis of Income Statement
In vertical analysis, components are presented as a percentage of the net sales (Peterson & Fabozzi, 2012). In 2013, Family Dollar’s cost of goods was a higher percentage of net sales compared to Dollar Tree’s. In 2013, Family Dollar cost of goods sold was 65.79% of net sales compared to 64.13% for Dollar Tree. It was also higher in 2012, and 2011 (see Appendix A). A higher cost of goods sold results in lower ratios of gross profit as a percentage of net sales.
Family Dollar’s operating expenses are higher than Dollar Tree’s in 2013, 2012, and 2011 (see Appendix A). Looking at the operating expenses percentages, both firms improved their operating efficiency. By subtracting the percentages to look at the rate of improvement, Family Dollar may not be able to catch up with Dollar Tree’s efficiency because it is improving at a higher rate than Family Dollar’s rate of improvement.
Net income is the most important part because it covers what can be converted into shareholder value. Dividends are paid out of net income. A firm’s long-term growth relies on net income in the form of retained earnings. Retained earnings offer a lower cost of expansion than using debt as capital. In 2013, Family Dollar had 4.27% as net income compared with 8.38% for Dollar Tree. In 2012, Family Dollar had 4.53% against 7.36% for Dollar Tree. In 2011, it was 4.54% against 6.75% for Dollar Tree. Family Dollar is less profitable than Dollar Tree, which means lower dividend yields than for Dollar Tree. It also indicates that Family Dollar is unlikely to grow at a higher rate than Dollar Tree. Family Dollar is also unlikely to catch up with Dollar Tree’s efficiency because Dollar Tree is becoming more profitable when Family Dollar is becoming less profitable.
As an investor, Dollar Tree has a better performance than Family Dollar. Family Dollar is likely to have a lower dividend yield, and a lower growth rate than Dollar Tree. Stock prices are based on growth rate, or expected growth rate. If an investor were to choose between the two companies, based on vertical analysis, Dollar Tree is a better choice.
Horizontal Common-Size Analysis of Income Statement
The horizontal analysis considers a base year from which all percentages are calculated (Peterson & Fabozzi, 2012). Between 2011 and 2013, Family Dollar net sales increased to 121.57% compared with 125.71% for Dollar Tree (see Appendix B). It is an improvement of 21.57% for Family Dollar, and 25.71% for Dollar Tree. Family Dollar sales increased, but at a lower rate than Dollar Tree.
Dollar Tree will be able to catch up with Family Dollar’s size because it is run more efficiently, and it is more profitable. An investor’s worth is likely to increase at a higher rate holding Dollar Tree’s stocks than Family Dollar’s.
Vertical Common-Size Analysis of the Balance Sheet
Family Dollar manages cash holdings more efficiently than Dollar Tree. In 2013, Family Dollar held 3.80% of its total assets as cash compared with 14.53% for Dollar Tree. Efficiency requires that firms hold an amount enough to cover its daily operations.
Companies should hold inventories that are enough to satisfy short-term demand. In the variety stores, inventories form a larger proportion of assets. There was no much difference in the quantity of inventories held by the two companies under vertical analysis. However, Dollar Tree holds fewer inventories than Family Dollar (see Appendix C). As a result, Dollar Tree may be considered more efficient in managing inventory.
Family Dollar uses operating assets more efficiently than Dollar Tree. Family Dollar operating assets are around 2.5% of total assets in the four years compared with Dollar Tree’s which are around 5.5% in the four years (see Appendix C).
Managing accounts receivable and payable requires that one receives payment more frequently or sooner than one pays. It helps to manage cash holdings, and reduces the need for an overdraft. Family Dollar’s gross receivables were 3.8% in 2013 and 2.74% in 2012 when Dollar Tree held none. Family Dollar has payables that are 19.49% in 2013 and 19.99 in 2012 when Dollar Tree had 12.59% in 2013 and 12.31% in 2012. It shows that Dollar Tree manages receivables and payables more effectively than Family Dollar.
Horizontal Common-Size Analysis of the Balance Sheet
Both firms have reduced their cash holdings, which increases efficiency in managing cash. Family Dollar has a better improvement because of the wide range of reduction in percentages (see Appendix D).
Both firms reduced their marketable securities holdings, which may be as a result of unfavorable market conditions. Dollar Tree has a better improvement, reducing from 628.78% in 2011 to 0.0% in 2013 (see Appendix D).
Both firms increased inventories in almost similar rates in the four years. It may indicate that the industry requires more inventory as customers demand increases, or becomes more unpredictable.
Both firms have increased their use of fixed assets. Family dollar increased its fixed assets use at a higher rate than Dollar Tree. Using less fixed assets is more efficient.
Family Dollar long-term liabilities increased at a higher in the four years compared with Dollar Tree (see Appendix D). The percentages also indicate that Family Dollar long-term liabilities are likely to increase in the coming years. Dollar Tree tends to maintain a very low rate of increase. Long-term liabilities have almost doubled for Family Dollar when they have almost remained the same for Dollar Tree. A higher level of long-term liabilities reduces profits through interest expenses. It increases risk to investors. Dollar Tree provides more value added and less risk for an investor.
Ratio analysis
Liquidity Ratios
The numbers of days’ sales are held in accounts receivable measure how long a firm extends credit to customers (Chapter 13: Financial statement analysis, n.d.). Days’ sales in receivables ratio have increased between 2011 and 2013. Family Dollar is supposed to reduce the number of days in receivables to increase efficiency. Accounts receivable turnover measures the number of times cash is collected from accounts receivable accounts (Chapter 13: Financial statement analysis, n.d.). Accounts receivable turnover shows that the receivables were converted into cash 771 times in 2013 compared with 828 times in 2011. Family Dollar shows a decline in the frequency in which it collects cash from receivables, which is a decline in performance. Dollar Tree manages receivables more efficiently because a 0.0 ratio indicates cash is received promptly, or the firm does not extend credit to customers.
Inventory turnover measures the number of times inventory is cleared (Chapter 13: Financial statement analysis, n.d.). Both firms have almost similar frequencies in which they clear inventory, which is between 4 times and 5 times annually (see Appendix E). Inventory turnover in days gives the same measure as days’ sales in inventory.
Operating cycle is the number of days it takes to convert goods into sales, and collect cash from receivables (Gibson, 2010). The firms used on average 79 days to convert goods into cash in 2013, and 77 days in 2013. There is a slight decline in effectiveness.
The Current ratio and the acid test (quick) ratio measure a firm’s ability to settle its short-term debts (Mowen, Hansen & Heitger, 2009). A current ratio or a quick ratio of 1.0 confirms ability to clear short-term liabilities. Family Dollar’s current ratio is more than 1.5 in the three years. It indicates the firm’s ability to pay its short-term debt. Dollar Tree has maintained a current ratio above 2.0 in the three years. Family dollar has an acid test ratio lower than Dollar Tree’s. The large differences between the current ratio and quick ratio show that both firms keep a large proportion of their current assets as inventories. Based on the acid test, both firms would have fallen into problems if their stocks of goods were to become immovable.
Cash flow adequacy ratio measures the ability to cover capital expenditures, long-term debts, and dividends from operating cash flows (Mowen, Hansen & Heitger, 2009). Dollar Tree has more ability to cover the costs than Family Dollar.
The industry manages inventory more efficiently than the two firms as shown by the inventory turnover ratio (see Appendix E). The industry’s average ratio is 7.37 when Family Dollar had 4.66 and Dollar Tree 4.88. A higher frequency is more efficient. Dollar Tree has better current and quick ratios than the industry’s average. The industry’s average current and quick ratios are better than for Family Dollar.
Long-term debt ratios
Times interest earned is obtained by dividing operating profit by interest expense. It measures ability to cover interest payments on long-term debt (Sarngadharan & Kumar, 2011). Family Dollar has maintained a stable trend. Dollar Tree has increased its ability to pay out interest expense. It has more than tripled its abilities in 2013 compared with 2011. Dollar Tree will realize much greater ease in paying interest on debt than Family Tree.
Fixed charge coverage measures ability to cover interest expense and leasing expenses (Gibson, 2010). Family dollar has a lower ratio than Dollar Tree during the three years. Dollar Tree has more ability than Family Dollar in paying interest on loans and leasing costs. The ratio also indicates that Dollar Tree uses a lot of leased property than Family Tree.
Debt ratio measures the proportion of a firm’s net worth financed with debt (Mowen, Hansen & Heitger, 2009). About 60% of Family Dollar’s net worth is financed by debt compared with about 40% of Dollar Tree. Both firms have maintained stable trends on debt. Higher levels of debt increase risk. Dollar Tree is less risky than Family Dollar for an investor.
Debt to equity ratio compares debt with equity. A higher ratio of debt than equity increases risk for an investor (Mowen, Hansen & Heitger, 2009). As discussed in the balance sheet analysis, risk refers to the likelihood of sharing profits, and the ability to retain equity in case of bankruptcy. On a trend analysis, Family Dollar is working towards reducing its debt to equity ratio as it can be seen in the three years. Dollar Tree has maintained its debt equity ratio at the same level. Dollar Tree is less risky for an investor.
Debt to tangible net worth refers to debts to fixed assets ratio. Dollar Tree has a better proportion of assets compared with their level of debts (see Appendix F).
Cash flow to total debt ratio shows ability to generate cash to service and repay debt. Dollar Tree has a higher ability than Family Dollar to generate cash to pay debts (see Appendix F).
Both firms show a higher ability to cover interest expenses than the industry’s average score. The industries debt/ equity ratio is lower than both firms. It shows that the firms are more risky than the industry.
Profitability Ratios
Net profit margin shows the percentage of revenue that may be shared by shareholders. In the three years, Family Dollar has maintained its trend when Dollar Tree has improved (see Appendix G). Dollar Tree has a higher proportion to keep as retained earnings, or to share as dividends.
Total asset turnover measures effectiveness of using assets to generate sales (Chapter 13: Financial statement analysis, n.d.). An increasing ratio is preferable because it means the same assets are generating more sales. Total asset turnover indicates that there is no much difference in effectiveness between the two firms in using assets to generate sales (see Appendix G).
Return on assets indicates that Dollar Tree more efficiently generated profits from its assets than Family Dollar. Family Dollar’s efficiency in using assets to generate profits has declined when Dollar Tree’s has improved (see Appendix G).
Operating income margin measures operating efficiency. The tables indicate that Family Dollar’s operations have consistently become less efficient when Dollar Tree’s has consistently become more efficient.
Operating asset turnover examines how many times a unit of operating assets generates a unit in sales. There is no much difference in the effective use of operating assets to generate sales between the two firms. The trend is also fairly stable among the two companies.
Sales to fixed assets ratio shows the effective use of fixed assets in generating revenues. Family Dollar uses fixed assets less effectively than Dollar Tree.
Return on investment explains the relationship between investment in assets and net income (Mowen, Hansen & Heitger, 2009). Dollar Tree generates more profits from its investment in assets than Family Dollar. Dollar Tree efficiency has improved when Family Dollar’s has declined.
Return on total equity measures efficiency in generating returns for the owners of the firm (Chapter 13: Financial statement analysis, n.d.). Family Dollar generates a lower percentage than Dollar Tree. Family Dollar’s performance has declined when Dollar Tree’s has improved consistently over the three years. Return on common equity is may indicate that the firm has issued common shares only.
Both firms reported higher net profit margin than the industry (see Appendix G). In 2013, the industry reported a 3.55% net profit margin. Family Dollar had 4.27% and Dollar Tree 8.38%. Both firms scored higher on ROE, ROI, and gross profit margin than the industry’s average (see Appendix G). It shows that the firms had better financial performance than the industry’s average.
Investor Analysis
Degree of leverage shows the sensitivity of net income to changes in earnings before interest and taxes (Besley & Brigham, 2008). A 1.04 degree of leverage shows net income changes by 1.04 when the EBIT changes by 1.0. Family Dollar net income is more sensitive to interest payment than Dollar Tree, which makes it more risky than Dollar Tree.
Earnings per share show the amount in dollars that is distributed from net earnings to common shares (Chapter 13: Financial statement analysis, n.d.). Dollar Tree added more value to shareholders than Family Dollar. Dollar Tree has consistently increased EPS through the three years when Family Dollar’s contribution is negligible.
Price/Earnings ratio compares stock prices with EPS (Gibson, 2010). A higher market price requires a higher EPS to maintain the same level of P/E ratio. Compared with the market price, the Dollar Tree P/E ratio has improved (see Appendix H). A smaller ratio shows that the earnings are a bigger proportion of the market price.
Retained earnings show the percentage of net income reinvested in the firms. A higher level of reinvestment promises future growth, and higher value added to investors. However, it also shows fewer dividends for a short-term investor. For a short-term investor, Family Dollar may be a better choice. For a long-term investor, Dollar Tree provides a better choice.
Dividend yield shows the dividend as a percentage of the market price (Besley & Brigham, 2008). In the last three years, Family Dollar shows an improvement by having a larger percentage.
Year-end market prices show that both firms created value for shareholders with an increase of about $15 per share for both firms within the three years. Based on the change, their performances appear equal. However, a firm with a higher price should have a larger change in price.
Averagely, the industry performed better than Dollar Tree on investor analysis ratios. The industry reported a 17.1 price/ earnings ratio when Dollar Tree reported 14.97 in 2013. Dividend yield is also higher for the industry (2.4%) than for Dollar Tree (1.41%). The industry must have performed better than Family Dollar because Dollar Tree is the better of the two (see Appendix H).
Overall analysis
Dollar Tree has a better financial performance than Family Dollar. Dollar Tree obtains goods at a slightly lower cost than Family Dollar. Dollar Tree is operating more efficiently than Family Dollar. As a result, Dollar Tree is more profitable than Family Tree. Dollar Tree uses assets more efficiently, which creates more value for shareholders. Dollar Tree reinvests a higher proportion of its earnings, which indicates that it may at a higher rate than Family Dollar. Both firms are above average in many areas compared with industry averages except in dividend yields.
Conclusion and Recommendations
Conclusion
Dollar Tree provides a better opportunity for a long-term investor, and a short-term investor. A long-term investor examines a firm’s expansion prospects, which depends on retained earnings and returns on investment. Short-term investment will depend on a firm’s ability to pay dividends, and increases in the stock price. If an investor would have invested an equal amount in both firm’s stocks during the three years, he would have earned more at Dollar Tree than Family Dollar. The price changes are almost equal, but Dollar Tree’s stocks are cheaper. Family Dollar has a lower dividend yield, and a lower growth rate than Dollar Tree. Dollar Tree will be able to catch up with Family Dollar’s size because it is run more efficiently, and it is more profitable. An investor’s worth is likely to increase at a higher rate holding Dollar Tree’s stock than Family Dollar’s. Family Dollar’s higher level of long-term liabilities reduces profits through interest expenses. It increases risk to investors. Dollar Tree will realize much greater ease in paying interest on debt than Family Tree. The industry manages inventory more efficiently than the two firms. The industry performed better than the two firms on dividend yield, and price/ earnings ratio. Both firms are above average in other areas. Value creation for an investor relies on profitability, growth prospects, and efficiency, all which Dollar Tree has a better performance than Family Dollar. Stock prices are based on investor confidence derived from the same factors. Dollar Tree is a better choice for the investor. Dollar Tree provides more value added and less risk for an investor.
Recommendations to the investor
The investor should invest in Dollar Tree because of the following reasons.
- It has higher net sales growth rate than the competitor.
- Its profitability is higher, which is also increasing at a higher rate than the competitor. Its profitability increases at a rate that is about three times that of the competitor.
- Its operations are managed more efficiently than the competitor.
- It shows a much higher capability of meeting its short-term and long-term debt obligations from operating cash flow than the competitor.
- It uses less leverage, which provides less risk to the investor than the competitor.
- It uses assets more efficiently to generate net income than the competitor.
- It has higher earnings per share than the competitor, which is likely to increase an investor’s worth at a higher rate than the competitor.
- It has higher retained earnings, which indicates that it may grow at a higher rate than the competitor.
- It operates above the industry’s average in profitability, liquidity, and operating efficiency.
References
Besley, S., & Brigham, E. (2008). Essentials of managerial finance (14th ed.). Mason, OH: Thomson/ South-Western.
Chapter 13: Financial statement analysis. (n.d.). Web.
Gibson, C. (2010). Financial reporting and analysis: Using financial accounting information. Mason, OH: Cengage Learning.
Mowen, M. M., Hansen, R. D., & Heitger, L. D. (2009). Cornerstones of managerial accounting (3rd ed.). Mason, OH: South-Western Cengage Learning.
Peterson, P.P., & Fabozzi, J. F. (2012). Analysis of financial statements (2nd ed.). Hoboken, NJ: John Wiley & Sons.
Sarngadharan, M., & Kumar, R. (2011). Financial analysis for management decisions. New Delhi, India: PHI Learning Private.
Appendices
Vertical Common-Size Analysis: Appendix – A
Horizontal Common-Size Analysis:- Appendix – B
Vertical Common-Size Analysis:- Appendix – C
Analysis of Balance Sheet.
Horizontal Common-Size Analysis:- Appendix – D
Liquidity Ratio:- Appendix – E
Ratio Analysis.
Sources for the industry figures:
General merchandise and variety stores. (2014). Web.
Industry Center – Discount, variety stores. (2014). Web.
Walmart stores Inc (NYSE: WMT) (2014). Web.