Image Shown: Shares of Dollar General Corporation have surged higher in recent years. We see room for additional upside.
By Callum Turcan
One of our favorite retailers out there is Dollar General Corporation (NYSE:DG), which operates over 16,700 convenience stores across 46 states in the US. We appreciate the resilience of Dollar General's business model in the face of any economic environment, as the firm's strong performance during the initial stages of the ongoing coronavirus ("COVID-19") pandemic can attest to (we will cover that in this article).
Dollar General's business is built around catering to small cities and towns with populations of 20,000 or less, selling a variety of consumer staples and consumer discretionary products. Dollar General's strategy makes it harder for the brick-and-mortar retailer to get disrupted by the rise of e-commerce, in our view, given the logistical hurdles that firms like Amazon (AMZN) face when catering to regions with low population densities.
E-commerce works best in areas with high population densities given the ability to centralize distribution networks and meet last-mile delivery services without incurring hefty incremental costs. In regions where customers are located far away from distribution networks and last-mile delivery services are not all that viable given the distance between each final destination, e-commerce is far less appealing given that the incremental fulfillment costs ultimately are passed on to the customer (in most instances), which makes home delivery services far less appealing for most products.
Dollar General has invested heavily in its digital operations over the past few years, including its DG Pickup initiative which allows customers to order online and pickup those products at "Pickup shelves" located in specified areas within its stores (which allow for "contactless" fulfillment). Contactless fulfillment offerings have become quite popular during the pandemic due to US households (and households worldwide) seeking to socially distance. Dollar General has been able to keep up with the competition on this front, keeping the logistical hurdles of home delivery offerings in mind as it concerns the regions Dollar General caters to.
The company reported stellar year-over-year same-store sales growth of 18.8% during the second quarter of fiscal 2020 (period ended July 31, 2020), a period that included the initial stages of the COVID-19 pandemic in the US. Elevated demand for consumer staples products during this period was partially responsible, though Dollar General noted strength was witnessed across numerous product categories.
Beyond improvements to its digital operations, part of Dollar General's success was due to its DG Fresh initiative. Among other things, this initiative involves building out new distribution facilities to help keep its stores stocked with perishables (fresh and frozen foods). Additionally, Dollar General has been aggressively adding coolers to its stores, enhancing its inventory management system which in turn helped grow its perishable foods sales along with its beer and wine sales.
Longer term, these moves are helping Dollar General steadily roll out produce offerings to its convenience stores, though only a relatively modest portion of its current locations have meaningful produce offerings. During Dollar General's latest earnings call, management noted the firm added produce offerings to over 120 of its stores during the first half of fiscal 2020, bringing the total up to more than 870 stores (roughly 5% of its total store count).
Management has steadily been laying the groundwork for Dollar General to push deeper into the produce arena, and please note this represents a major source of growth going forward. Dollar General is also adding a greater number of products to its stores through its Non-Consumables Initiative ("NCI"). We appreciate the company's long-term focus on optimization and innovation.
Dollar General is simply a fantastic business. From fiscal 2018 to fiscal 2020, Dollar General's annual free cash flows (defined here as net operating cash flow less capital expenditures) averaged $1.3 billion. Its annual dividend obligations during this period averaged $0.3 billion, though Dollar General allocated a significant amount of capital towards share repurchases as well during this period ($0.9 billion per fiscal year on average). Both activities were fully covered by its internally generated free cash flows on average.
This strength continued during the first half of fiscal 2020, when Dollar General generated $2.5 billion in free cash flow while spending $0.7 billion on share repurchases and $0.2 billion on its dividend obligations. At the end of July 2020, Dollar General had $3.0 billion in cash and cash equivalents on hand with no short-term debt on the books and $4.1 billion in "long-term obligations" on hand, good for a manageable net debt load of approximately $1.1 billion.
Looking at Dollar General's income statement, the firm's GAAP revenues rose 26% year over year during the first half of fiscal 2020, aided by rising same-store sales and a growing store count (the company added over 440 net stores to its operations during the first half of fiscal 2020). Dollar General announced it had opened its first store in Wyoming in March 2020, and in April 2020, the retailer announced it had opened its first store in Washington state. We see Dollar General having a promising long-term growth runway.
As it concerns its margins, Dollar General reported its GAAP gross margin rose by ~110 basis points in the first half of fiscal 2020 on a year-over-year basis, while its GAAP operating margins rose by over 310 basis points during this period. Greater non-consumable sales, higher initial markups, and a reduction in markdowns along with economies of scale helped improve Dollar General's financial performance. This speaks very favorably towards its long-term outlook, as rising margins combined with growing revenues represents a powerful combination for net operating cash flow growth and ultimately free cash flow growth.
Though Dollar General is expanding its net store count and thus is spending a meaningful amount on capital expenditures (including $0.8 billion in fiscal 2019), the retailer's capital expenditures relative to its cash flows are relatively tame which is why the firm is able to generate sizable free cash flows. Dollar General increased its capital expenditure expectations for fiscal 2020 during its latest earnings update as the retailer seeks to take advantage of elevated demand for consumer staples products in the US.
In the upcoming graphic down below, we highlight our growth expectations for Dollar General's net operating cash flows and free cash flows over the coming fiscal years. Please note that within the upcoming graphic down below, the grey line represents our "base case" scenario, the blue dots represent our "bull case" scenario, and the green dots represent our "bear case" scenario in terms of the key valuation assumptions used in our enterprise cash flow models.
Image Shown: We see Dollar General's growth outlook as one that is quite promising under any economic scenario. Image Source: Valuentum
There are several risks to be aware of here when analyzing Dollar General. For starters, domestic consumer spending levels during the initial stages of the COVID-19 pandemic were held up by significant cash transfers to US households that were included as part of the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") that was passed in March 2020. Those cash transfers included direct payments to US households under certain income thresholds and enhanced unemployment benefits, though please note that the direct cash transfers were a one-time deal and enhanced unemployment benefits have since expired.
Considering that talks over another round of emergency fiscal measures are progressing very slowly through Congress, and given US unemployment rates remain elevated (the official unemployment rate in the US was 8.4% in August 2020), there is a chance domestic consumer spending levels will shift significantly lower over the coming months, especially after the holiday shopping season ends. This could weigh on Dollar General's near-term outlook. The trajectory of the domestic economy has an outsized impact on Dollar General's financial performance.
Additionally, should Dollar General see competition increase in the regions it operates in, that would pressure its outlook. We remain confident that e-commerce offerings are not all that economical in regions with low population densities, though competitive threats always need to be monitored in the retail space.
Dollar General is one of the best retailers out there and we continue to be huge fans of the name. Back in March 2019, we wrote an article on Seeking Alpha (link here) highlighting why we liked the company, and since then Dollar General has continued to impress us. Shares of DG yield a modest ~0.7% as of this writing and we like its dividend growth outlook. The retailer's dividend program offers incremental income upside to the significant capital appreciation upside Dollar General offers investors.
This article was written by
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Callum Turcan does not own shares in any of the securities mentioned above. Dollar General Corporation (DG) is included in Valuentum’s simulated Best Ideas Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
The financial health and growth prospects of DG, demonstrate its potential to perform inline with the market. It currently has a Growth Score of D. Recent price changes and earnings estimate revisions indicate this would be a good stock for momentum investors with a Momentum Score of A.Will DG stock go up? ›
Stock Price Forecast
The 22 analysts offering 12-month price forecasts for Dollar General Corp have a median target of 274.00, with a high estimate of 296.00 and a low estimate of 199.00. The median estimate represents a +5.25% increase from the last price of 260.33.
Dollar General Stock Declines After Q2 2021 Earnings Report
The company noted that same-store sales declined by 4.7% compared to the second quarter of 2020 due to decline in customer traffic.
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|The Vanguard Group, Inc.||7.59%||17,124,004|
|Capital Research & Management Co....||5.75%||12,967,398|
|BlackRock Fund Advisors||4.99%||11,254,495|
|DG Split History Table|
|03/01/1993||3 for 2|
|09/20/1993||5 for 4|
|03/07/1995||4 for 3|
Number of shares outstanding for Dollar General (DG)
At the end of 2022 the company had 226,299,000 shares outstanding.