“A great business at a fair price is superior to a fair business at a great price.”
This quote is often attributed to Warren Buffett (Trades, Portfolio), but it is actually a Charlie Munger quote. What Munger, the vice chairman of Buffett’s Berkshire Hathaway (BRK.A, Financial)(BRK.B) conglomerate, meant by this statement is that he prefers excellent companies trading near their fair valuation to average companies trading at a discount. Excellent companies often tend to outperform average ones. Investors can even extrapolate this statement to include a great business trading at a discount to the market as a whole.
One company that I find to be an excellent business that is attractively valued against its own history and that of markets as a whole is Dollar General (DG, Financial).
Company background
Dollar General traces its history back to 1939. The company, which sells many of its products for less than a dollar, has only traded publicly since late 2009. Consumers can buy an assortment of merchandise at their local Dollar General, everything from apparel to home products to groceries.
Dollar General has nearly 15,000 stores in the U.S., with an overall goal of having 25,000 stores nationwide. Nearly three-quarters of the country’s population live within five miles of a Dollar General. Whereas other large retailers tend to avoid less populated areas, two-thirds of Dollar General’s stores are in small towns (those with less than 20,000 residents). This gives Dollar General a wide customer base to which it can sell its nearly 10,000 products.
Recent earnings results
Dollar General most recently reported quarterly earnings results on Aug. 30. The company earned $1.52 per share during the second quarter of fiscal 2018, beating estimates by 3 cents and improving 38% year over year. Dollar General’s revenue grew 10% to $6.44 billion, $70 million above what the market expected. Same store sales improved 3.7% due to both higher traffic and basket size. A tax rate of 21.6%, compared to 37.2% in the second quarter of fiscal year 2017, also helped drive earnings growth.
Even though Dollar General has seen same-store sales increase for the past 28 years, the company isn’t resting on its past success. In order to help grow, Dollar General has been very aggressive in its capital spending. Dollar General expects to open 900 new stores, remodel 1,000 stores and relocate another 100 stores during this year. At a time when many retailers are reducing their store count, Dollar General is ramping up theirs.
In recent years, the company has added cooler space to its stores. Dollar General expects to install 20,000 cooler doors across its fleet of stores in 2018. These coolers help make the store a one-stop shop for its customers and drive up the average basket price.
Dollar General has also placed national and private health and beauty products in approximately half of its stores in an attempt to draw in even more customers. The company has seen its digital coupon subscribers total increase to 14 million individual accounts during the most recent quarter. Subscribers used more than 400 million digital coupons during the first half of the year.
Besides impressive recent earnings results and improvements to stores, one reason I think so highly of Dollar General is its resiliency during adverse economic conditions. From 2008 to 2009, when most companies saw their earnings decline, Dollar General saw earnings grow. Actually, earnings per share more than tripled during this time from 34 cents to $1.04 per share. And this was during a period where the share count actually increased more than 7%.
Dollar General forecasts a midpoint for earnings per share for 2018 of $6.05. This would represent almost 35% growth from 2017. The company also sees sales growing by at least 9% this year.
Dividend history and valuation
Dollar General is a relatively young dividend-paying company, having only issued a dividend since 2015. Dividends for the year:
- Increased 10.2% from 2015 to 2016.
- Increased 6.2% from 2016 to 2017.
- Is expected to increased 9.7% from 2017 to 2018.
Shares currently only yield 1.12%, which is less than the yield of the S&P 500 (1.81%), but the company has shown fairly impressive dividend growth rates so far in its young dividend paying history.
Even better, Dollar General has plenty of room to increase its dividend. Since initiating its dividend, Dollar General has had an average payout ratio of just 22.7%. The company will pay out $1.13 per share in dividends this year. Based off of expected earnings per share guidance, the company will have a payout ratio of less than 19% this year.
Dollar General has been a cash-flow generating machine through the first half of 2018. Cash flows have increased almost 40% to $1.1 billion. During the second quarter, Dollar General repurchased 2.1 million of its own shares and has returned a total of more than $500 million to shareholders so far this year.
Based on Friday’s closing price of $103.76 and expected earnings per share, Dollar General’s stock trades with a price-earnings ratio of 17.2. Since becoming a publicly traded company in 2009, the stock has averaged a price-earnings ratio of 17.7. This means that shares are slightly undervalued relative to their history. By comparison, the price-earnings ratio of the S&P 500 is 23.6. When placed against the broad market, Dollar General appears to be very attractively priced, especially given the earnings and sales growth expectations for 2018.
Final thoughts
Dollar General posted impressive same-store sales and earnings growth during the second quarter. With nearly three decades of same-store sales increases, Dollar General has managed multiple economic cycles and still managed to show growth. The company’s dividend history is short, but the payout ratio should allow for raises for the foreseeable future.
Given that Dollar General is willing to spend to improve and increase its store count while seeing customer traffic and basket size grow, shares might be severely undervalued. The stock trades below its historical valuation and well below the market multiple. This could mean that Dollar General is an excellent company, trading at a fair price.
Disclosure: I am not long any of the stocks mentioned in this article.
