Family Dollar Stores Inc.

January 21, 2015 Family Dollar Stores Inc. Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 01/21/2015 Current Price (01/20/15) $75.43 Target Price $79.00 52-Week High $80.23 52-Week Low $56.08 One-Year Return (%) 16.70 Beta 0.39 Average Daily Volume (sh) 2,077,074 Shares Outstanding (mil) 114 Market Capitalization ($mil) $8,633 Short Interest Ratio (days) 3.42 Institutional Ownership (%) 90 Insider Ownership (%) 10 (FDO-NYSE) SUMMARY Family Dollar decided to stick to Dollar Tree and rejected Dollar General s buyout offer on grounds of antitrust concerns. The giant that will arise will have the ability of generating sales of over $18 billion and reach out more consumers through its vast network of stores. Moreover, the deal could bring breather to Family Dollar, which has been in troubled waters for some time now. The heightened competition from other retail bellwethers has affected the company s profitability. In the recently concluded quarter, the company saw its earnings per share declining 35.3% year over year, and missing the Zacks expectation for the fifth straight quarter. Battered by a competitive retail landscape, Family Dollar has outlined a set of strategic actions to rein in the hay wired financial performance, which has started yielding results. This is well evident from the comps growth of 1.2% in December. Consequently, we upgraded our recommendation on the stock to Neutral. Risk Level * Low, Type of Stock Large-Growth Industry Retail-Discount Zacks Industry Rank * 64 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Nov) (Feb) (May) (Aug) (Aug) Annual Cash Dividend $1.24 Dividend Yield (%) 1.64 5-Yr. Historical Growth Rates Sales (%) 8.0 Earnings Per Share (%) 6.1 Dividend (%) 18.9 2013 2,422 A 2,894 A 2,574 A 2,502 A 10,391 A 2014 2,500 A 2,717 A 2,659 A 2,614 A 10,489 A 2015 2,556 A 2,796 E 2,718 E 2,735 E 10,805 E 2016 2,703 E 11,412 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year using TTM EPS 26.7 (Nov) (Feb) (May) (Aug) (Aug) 2013 $0.69 A $1.21 A $1.05 A $0.86 A $3.80 A using 2015 Estimate 27.8 2014 $0.68 A $0.80 A $0.85 A $0.73 A $3.05 A using 2016 Estimate 26.9 2015 $0.44 A $0.72 E $0.81 E $0.74 E $2.71 E 2016 $0.51 E $2.80 E Zacks Rank *: Short Term The quarterly figures may not add up to annuals due to rounding off 1 3 months outlook 3 - Hold Projected EPS Growth - Next 5 Years % 8 * Definition / Disclosure on last page 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606

OVERVIEW Founded in 1959 and headquartered in Matthews, NC, Family Dollar Stores, Inc. (FDO) operates a chain of self-service retail discount stores in the United States. It offers general merchandise in four categories: Consumables, Home Products, Apparel and Accessories, and Seasonal and Electronics. The company trades in merchandise generally priced in the range from under $1 to $10. The company operates over 8,101 general merchandise retail discount stores across 46 states, as of November 29, 2014. The company offers general merchandise in four categories: Consumables, Home Products, Apparel and Accessories, and Seasonal and Electronics. The Consumables category (73% of fiscal 2014 total revenue) consists of household chemicals; paper products; candy, snacks and other food; health and beauty aids; hardware and automotive supplies; and pet food and supplies. The Home Products category (10% of fiscal 2014 total revenue) includes domestic items, such as blankets, sheets, and towels; housewares; giftware; and home decor. The Apparel and Accessories category (7% of fiscal 2014 total revenue) comprises men's and women's clothing; boys', girls' and infants' clothing; shoes; and fashion accessories. The Seasonal and Electronics category (10% of fiscal 2014 total revenue) includes toys, stationery and school supplies; seasonal goods; and personal electronics, including pre-paid cellular phones and service. REASONS TO BUY Family Dollar Stick on a Merger Deal with Dollar Tree: Family Dollar is trying all means to convince its shareholders to favor the pending deal with Dollar Tree. The giant that will arise once the deal is closed will be strong enough to single-handedly counter competition from other retail bellwethers. The combined chain, with the ability of generating sales of over $18 billion, will be in a better position to reach out to more value-seeking consumers through its vast network of more than 13,000 stores spanning 48 states and five Canadian Provinces. The buyout, which will help Dollar Tree to emerge as a leading discount retailer in North America, will also assist in providing customers with products at a fixed price ($1 or less) under its banner and multi-price point under Family Dollar. The acquisition will enhance the buying power of the pair, providing better negotiating terms against suppliers. The combined company will be able to offer broader and multiple assortments at more compelling prices. Moreover, the transaction will help in achieving operational and distribution efficiencies as well as cost synergies. Dollar Tree anticipates savings of $300 million in annual costs by the end of the third year, after the deal is closed. Post-acquisition, the companies will be able to tap new markets, enhance market share in existing ones, extend the sales channel and generate significant free cash flow to increase store count and repay debt. Business Overhauling: Battered by a competitive retail landscape, Family Dollar has outlined a set of strategic actions to be implemented immediately to rein in the hay wired financial performance. Management reduced prices of approximately 1,000 basic items, investing $50 million annually to add value-based products, optimizing the cost structure by lowering headcount, closing underperforming outlets and is being more rationale on new store opening to reap higher return on investment. The company, in fiscal 2015, plans to extend its cooler facilities, roll out products such as wine and beer to draw traffic, and undertake initiatives to enhance store productivity. The company Equity Research FDO Page 2

expects a benefit of approximately $40 $45 million annually on account of store closures and trimming of workforce. Furthermore, Family Dollar has been adding new items to its food assortment with special emphasis on national brands to increase footfall. Moreover, it has taken off several items from its shelves which generated tepid customer response. Going forward, these merchandising initiatives along with the company s commitment towards better price management, cost containment, effective inventory management, private label offering and expanded operating hours should drive sales and margin trends. Sustenance of Shareholder Return Program: In spite of a weak financial performance, Family Dollar has maintained its shareholder wealth maximizing program. During fiscal 2014, the company bought back approximately 1.8 million shares for an aggregate amount of $125 million and paid dividend of $130.1 million. Moreover, the company declared a 19.2% hike in its quarterly dividend to $0.31 per share in Jan 2014, which appealed to investors. Changes in Investments Strategy: Family Dollar has been witnessing low returns on invested capital (ROIC), given shrinking operating margin and increasing capital investments. To improve ROIC, the company has decided to rationalize its store portfolio. Moreover, after careful evaluation Family Dollar has decided to shutter stores with higher risk and start slowing down its store growth from fiscal 2015. After opening 526 stores in fiscal 2014, the company now plans to open 375 new locations in fiscal 2015. During first-quarter fiscal 2015, Family Dollar opened 59 new outlets taking the total store count to 8,101. The company also renovated, expanded or relocated 178 stores. REASONS TO SELL Gross Margin To Remain Under Pressure: Management expects gross margin to remain compressed due to increase sale of low margin consumables and soft sales of discretionary products. This is consistent with the trend witnessed in the first quarter of fiscal 2015, wherein gross margin declined 90 bps year-over-year to 33.4%. Dismal Earnings Pushing Earnings Estimate Down: Family Dollar s dismal first-quarter fiscal 2015 earnings performance has made investors wary. The company posted quarterly earnings of $0.44 per share that missed the Zacks Consensus Estimate of $0.59, and plunged 35.3% from $0.68 earned in the prior-year quarter. Stiff competition and margin contraction hurt the results. This triggered a massive downward revision in the Zacks Consensus Estimate for both fiscal 2015 and 2016. Cannibalization a Threat: The company s expansion in the geographies, where it already serves could boomerang. This may cannibalize sales performance and lower traffic counts at individual stores. Consequently, this may have a negative impact on the company s overall performance. Competitive Pressure: Family Dollar operates in the highly competitive discount retail merchandise sector. The company faces stiff competition from Wal-Mart and Dollar General, which will likely continue to weigh on its results. The competitors have larger number of stores, greater market presence, brand recognition and financial resources. Equity Research FDO Page 3

RECENT NEWS Family Dollar Keen on Dollar Tree's Buyout, Seeks Votes January 12, 2015 Family Dollar Stores Inc. is trying all means to convince its shareholders to favor the pending deal with Dollar Tree, Inc. (DLTR). The vote on the bid has already been postponed twice and Dollar Tree is in no mood to delay the meeting that has been rescheduled for Jan 22, 2015. Family Dollar decided to stick with Dollar Tree s buyout offer of $8.5 billion despite a higher bid of $9.1 billion from Dollar General Corporation (DG). Matthews, NC-based Family Dollar cited antitrust concerns behind the rejection of Dollar General s proposal. Family Dollar, in a recent letter to shareholders, highlighted the reviews of Federal Trade Commission ( FTC ). The company stated that accepting Dollar General s proposal would involve divestment of 3,500 to 4,500 stores, but a deal with Dollar Tree would require divestiture of about 310 stores. The company also remains optimistic about concluding the transaction by March, and informed that Dollar Tree has found potential buyers for the stores to be offloaded. The giant that will arise once the deal between Family Dollar and Dollar Tree is closed will be strong enough to single-handedly counter competition from retail bellwethers such as Wal-Mart Stores Inc. (WMT) in the dollar-discount store segment. The combined chain, with the ability of generating sales of over $18 billion, will be in a better position to reach out to more value-seeking consumers through its vast network of more than 13,000 stores spanning 48 states and five Canadian Provinces. The buyout, which will help Dollar Tree to emerge as a leading discount retailer in North America, will also assist in providing customers with products at a fixed price ($1 or less) under its banner and multi-price point under Family Dollar. The acquisition will enhance the buying power of the pair, providing better negotiating terms against suppliers. The combined company will be able to offer broader and multiple assortments at more compelling prices. Moreover, the transaction will help in achieving operational and distribution efficiencies as well as cost synergies. Dollar Tree anticipates savings of $300 million in annual costs by the end of the third year, after the deal is closed. Post-acquisition, the companies will be able to tap new markets, enhance market share in existing ones, extend the sales channel and generate significant free cash flow to increase store count and repay debt. Family Dollar Q1 Earnings Miss Estimate, Plunge Y-o-Y January 8, 2015 Family Dollar Stores Inc. posted first-quarter fiscal 2015 earnings of $0.44 per share that missed the Zacks Consensus Estimate of $0.59, and plunged 35.3% from $0.68 earned in the prior-year quarter. Stiff competition and margin contraction hurt the results. To bring itself back on the growth trajectory, this self-service retail discount store chain had earlier announced a slew of measures to improve its operational and financial performances. Management reduced prices of approximately 1,000 basic items and disclosed plans to add value-based products, optimize the cost structure by lowering headcount, reduce inventory shrinkage, close underperforming outlets and being more rationale on new store opening to reap higher returns on investment. The company is undertaking initiatives to enhance store productivity and remains focused on enhancing sales. This is well evident from the company s comparable-store sales performance so far in the second quarter. Comps grew 1.2% in December on account of fewer markdowns and increase in customer traffic. Equity Research FDO Page 4

Including fees associated to the pending merger with Dollar Tree Inc. (DLTR), the earnings came in at $0.36 per share, substantially down from the year-ago quarter. Family Dollar decided to stick to Dollar Tree and rejected Dollar General Corporation s (DG) buyout offer on grounds of difficulty to win over antitrust regulatory concerns. The giant that will arise will have the ability to generate sales of over $18 billion and reach out to more consumers through its vast network of stores. Let s Dig Further Family Dollar posted a 2.3% increase in net sales to $2,556.4 million from the prior-year quarter, reflecting sales growth across Consumables (up 3.5%) and Seasonal & Electronics (up 2.5%). This was offset by decline witnessed in Home Products (down 4.8%) and Apparel and Accessories (down 1%). Total revenue came below the Zacks Consensus Estimate of $2,577 million. The strength witnessed in the Consumables category came on the back of robust growth across frozen food and tobacco. Strong focus on consumables helped Family Dollar to drive business from budgetconstrained consumers. The Consumables category accounted for 75.8% of first-quarter net sales compared with 74.9% in the prior-year quarter. Comparable-store sales fell marginally 0.4% on account of decline in average consumer transaction value and lower customer transactions. Gross profit dropped marginally by 0.5% to $852.9 million, whereas gross margin contracted 90 basis points to 33.4%. The sturdy sales of lower-margin carrying consumables and lower markups were partly offset by lower markdowns. Family Dollar stated that adjusted operating profit for the quarter came in at $79.5 million, down 33.9% year over year. Operating margin shrunk about 170 basis points to 3.1%. Other Financial Details Family Dollar ended the quarter with cash and cash equivalents of $209 million, long-term debt of $299.1 million, and shareholders equity of $1,686.7 million. Capital expenditures for the quarter totaled $103.5 million. During the quarter, the company paid $35.3 million in dividends. Store Update During the quarter, Family Dollar opened 59 new outlets taking the total store count to 8,101. The company also renovated, expanded or relocated 178 stores. Equity Research FDO Page 5

VALUATION Family Dollar Stores current trailing 12-month earnings multiple is 26.7X, compared with 39.3X, the industry average and 18.6X for S&P 500. Over the last five years, Family Dollar s shares have traded in a wide range of 14.0X to 28.1X trailing 12-month earnings. The stock is also trading at a premium based on forward earnings estimates. Our target price of $79.00, 29.2X 2015 EPS, reflects this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Family Dollar Stores, Inc. (FDO) 27.8 26.9 9.9 14.4 26.7 28.1 14.0 Industry Average 25.2 21.4 13.6 25.0 39.3 187.4 14.8 S&P 500 16.1 15.1 10.7 15.9 18.6 19.4 12.0 Ross Stores Inc. (ROST) 21.5 19.4 11.6 19.1 21.9 22.2 11.7 Dollar General Corporation (DG) 19.3 17.0 14.5 15.8 20.2 21.8 14.9 Dollar Tree, Inc. (DLTR) 21.5 18.7 16.2 17.6 22.3 25.4 13.9 Big Lots Inc. (BIG) 18.4 15.4 13.4 15.5 21.3 23.7 10.4 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Family Dollar Stores, Inc. (FDO) 5.4 6.5 2.9 21.6 0.2 1.6 12.4 Industry Average 6.2 6.2 6.2 8.4 1.2 0.7 49.0 S&P 500 5.1 9.8 3.2 24.8 2.0 Equity Research FDO Page 6

Earnings Surprise and Estimate Revision History Equity Research FDO Page 7

DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of FDO. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1114 companies covered: Outperform - 15.6%, Neutral - 77.9%, Underperform 5.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research FDO Page 8