Dollar General (DG, Financial), a prominent American discount retailer, has a vast presence with over 19,000 stores spread across 47 states. It offers a diverse range of branded and private-label products in various categories.
In the fiscal year 2022, the majority of its net sales, 80%, was derived from consumable goods like paper products, cleaning items, packaged and perishable food, tobacco and health and beauty supplies. Seasonal merchandise, comprising 11% of sales, included toys, greeting cards, decorations and gardening supplies. Home products, accounting for 6%, encompassed kitchen supplies, small appliance and cookware, while apparel made up 3% of sales.
Company history
Dollar General was founded by J.L. Turner and his son, Cal Turner Sr., in Scottsville, Kentucky, in 1939. In the 1960s, Dollar General underwent rapid expansion, so it went public in 1968 and was listed on the New York Stock Exchange.
In 2002, Dollar General was acquired by private equity firm Kohlberg Kravis Roberts & Co. (KKR, Financial). Under new ownership, the company implemented various strategic initiatives to enhance its operations and profitability. Dollar General experienced further growth and success in the following years. In 2009, the company surpassed 8,000 store locations nationwide. By 2011, it had become the first dollar store chain to reach $1 billion in annual sales.
In recent years, Dollar General has focused on optimizing its store formats, improving its product assortment and leveraging technology to enhance the customer experience. The company has expanded its presence in both rural and urban areas, catering to a broad customer base.
Key metrics
The following table summarizes some key valuation and quality metrics for Dollar General:
| GF Value | Significantly Undervalued | |
| GF Score | 83 | out of 100 |
| Predictability Rank | 4.5 | out of 5 |
| Growth Rank | 10 | out of 10 |
| Financial Strength | 5 | out of 10 |
| Valuation Rank | 4 | out of 10 |
| Quality Rank | 9 | out of 10 |
| Momentum Rank | 1 | out of 10 |
| Profitability Rank | 9 | out of 10 |
Looking at the quarterly growth over the last two years, we see that while the company came out of the pandemic slump strongly growth has begun to wane in the latest quarter.
Dollar General's first-quarter earnings report revealed a decrease in diluted earnings per share, primarily attributed to rising SG&A expenses. Despite this, the company's revenues continue to grow, albeit at a slower rate. In its latest guidance, Dollar General projected that its 2023 diluted EPS would experience an approximate 8% decline to remain flat, deviating from the previous expectation of 4% to 6% growth.
As one of my favored defensive stock picks, I expected Dollar General to navigate challenging times successfully. The unexpected guidance cut caused a significant shock, resulting in a 20% plummet in the stock price, with shares trading in the $150's during June. However, following the decline, the stock's valuation appears to be more reasonable and the stock has now rebounded over 10% from the lows.
In spite of facing increasingly strong competition, Dollar General possesses several key strengths, including a strategically located store network, a focus on low-priced items and efficient supply and distribution chains. These advantages should enable the company to continue generating economic value.
The company generates impressive return on equity as evidenced by the DuPont Analysis given below.
Dollar General's debt is quite high at 17.66 billion with a debt-to-equity ratio of 4.41 and an interest coverage ratio of 13.05. As of February 3, 2023, the company had a total long term debt of $5.54 billion, consisting of various senior notes with different interest rates and maturity dates. They also had two credit facilities: the Revolving Facility with a commitment of $2 billion and the 364-Day Revolving Facility. Both facilities had borrowing availability, and the company was in compliance with the associated covenants. Additionally, the company had outstanding letters of credit totaling $39.7 million. Inspite of the high debt, the company's balance sheet is healthy given the company's huge cash flow.
Dollar General's footprint is concentrated in sparsely populated areas where the market cannot sustain numerous retailers and where it has first mover advantage. Moreover, its offering of small-ticket items, with over 80% priced at or below $5, mitigates the threat from e-commerce rivals, ensuring convenience and affordability for its predominantly low-income customer base.
Dollar General heavily relies on consumables, which account for 80% of its sales in fiscal year 2022, to drive store traffic. Other product categories primarily serve to enhance margins and increase average transaction size. The company's recent efforts to introduce a dynamic range of non-consumable products provide customers with a treasure-hunt vibe that online-only retailers struggle to replicate. By adding coolers and expanding its health and beauty offerings, Dollar General aims to make its stores more appealing by offering a convenient location where a variety of essential items can be found. Remarkably, about 75% of Americans live within a five-mile radius of a Dollar General store.
Recognizing the importance of retail digitization, Dollar General has embraced technology, including the development of a mobile app that features digital coupons, generating valuable customer data while enhancing convenience. The company has also expanded the use of self-checkout in select stores, contributing to the overall value proposition and helping manage labor costs as minimum wages rise.
Dollar General faces intense competition from various sources, including convenience stores, mass merchandisers, hard discounters, grocery stores, pharmacy chains and online retailers. With low switching costs, executing effectively becomes crucial. Dollar General's management has thus far risen to the challenge, but maintaining agility to meet evolving customer demands will be essential going forward.
Valuation
Dollar General has on a 10-year historical basis traded at a price-earnings averaging 20. This may be a bit high given increasing competition and market saturation, so I would reduce the target price-earnings ratio to 18. Currently the stock is trading at a price-earnings ratio of ~16.5. This would imply about 10% undervaluation as compared to my target.
Using the GuruFocus discounted cash flow calculation, I get the results shown below (my assumptions for EPS, growth and discount rate are also shown below). Though Dollar General has grown earnings much faster than the 5% growth rate I am predicting in the calculations below, I think given the increasing competition and slowing growth it's better to be conservative.
Conclusion
When searching for investments, I like to look for high quality, predictable businesses at sensible prices to own for the long run. As Warren Buffett (Trades, Portfolio) once said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Dollar General fits this criteria in my opinion. It's a predictable growing business, providing an important service to the consumer and, most importantly, selling at a fair price.
