The retail discount store industry (or the dollar-store industry) provides consumable basic needs to customers primarily in the low- and middle-income brackets. More than one third of the industry’s customers live in households that earn less than $20,000 per year, making the group’s results counter-cyclical–as more households generate lower income due to poor economic conditions, store growth and same-store-sales opportunities increase. Still, competition is fierce among constituents and with many other retailers, including grocery stores. But given the niche low-price strategy of participants and their counter-cyclical nature, we tend to like the group.
Dollar General (DG) has been operating at a level higher than that of its dollar-store peers, but its outlook for fiscal year 2014, released in its fourth quarter report March 13, came up a bit short. The company’s fourth-quarter sales advanced 6.8%, while fourth-quarter same-store sales edged up a modest 1.3%. These numbers showed a deceleration from the pace of its third-quarter performance, where total sales jumped 10.5% and same-store sales advanced 4.4%. The fourth-quarter top-line expansion was also less than that of the full year, where sales jumped 9.2% on a consolidated basis and 3.3% on a same-store basis (marking the twenty-fourth consecutive year of same-store sales expansion). Free cash flow totaled $674.62 million, up more than 20% from last year’s mark of $559.76 million and representing about 3.9% of annual sales. We liked the growth rate in free cash flow during the year. On an adjusted basis, earnings per share leapt 10% to $3.20 per share for fiscal 2013.
Though the quarterly performance was impacted by severe winter weather and an aggressive retail market environment (the company said as much in the release), Dollar General was still very “cautious on the current operating environment” and “the many challenges that its core customer is facing in 2014”. The firm’s outlook for fiscal 2014 is provided below:
For the 2014 fiscal year, the Company expects total sales to increase 8 to 9 percent over the 2013 fiscal year. Same-store sales are expected to increase 3 to 4 percent. Adjusted operating profit for 2014 is expected to increase 2 to 5 percent. The Company expects SG&A as a percentage of sales to increase over 2013 SG&A as a percentage of sales. This guidance includes incremental SG&A of $35 million (or approximately $0.07 per share) relating to anticipated incentive compensation and $10 million to $15 million (or approximately $0.02 to $0.03 per share) of estimated additional costs resulting from the Affordable Care Act. In addition, SG&A in 2014 is expected to include approximately $10 million of additional expense due to the impact of the Company’s recent sale leaseback transaction. A portion of the proceeds from the sale leaseback transaction were utilized to repurchase 3.5 million shares of the Company’s common stock in the 2014 first quarter, resulting in estimated accretion to EPS of $0.01 to $0.02, net of incremental expense related to the sale leaseback. The impact of the sale leaseback transaction is included in the earnings guidance…Diluted EPS for the fiscal year is expected to be approximately $3.45 to $3.55, based on approximately 306 million to 307 million weighted average diluted shares, assuming share repurchases of approximately $1.1 billion. For the first quarter (13 weeks) ending May 2, 2014, the Company expects total sales to increase 7 to 8 percent and sales in same-stores to increase 2 to 3 percent over the 2013 first quarter. First quarter 2014 EPS is expected to be approximately $0.72 to $0.74. Capital expenditures are expected to be in the range of $450 million to $500 million in 2014. The Company plans to open approximately 700 new stores in 2014.
Though we liked that Dollar General is poised to show another year of same-store sales expansion, while adding a large number of new stores, the bottom line numbers came in a bit shy of what we were looking for. Still, despite the lower than expected profit outlook, more conservative capital spending should continue to drive a nice pace of free cash flow expansion at the company. We still believe Dollar General is one of the best operators in its industry, particularly on the basis of its stand-out third-quarter results (ended November 1), which were not impacted by weather.
Valuentum’s Take
Though we leave open the possibility that Dollar General will exceed its fiscal 2014 bottom-line forecasts on the prospect of improved cost controls, the competitive environment in the dollar-store space is heating up. Big Lots (BIG) is adding freezers and coolers to hundreds of stores to help capture more of the food stamp business. Wal-Mart (WMT) plans to open up 300 Neighborhood Markets and Walmart Express stores (these stores are a fraction of the size of its Supercenters), creating additional competition and potentially squeezing out longer-term growth plans for the discount retailer group. We think the likelihood of consolidation across the dollar-store space is becoming increasingly likely, as Wal-Mart stretches for growth. Wal-Mart could take a stab at either Dollar General or Family Dollar (FDO), or the latter two might combine to achieve greater scale, density, and purchasing synergies to compete against Wal-Mart and Target (TGT). We think the dollar-store space will be one of the most exciting to watch over the next 12-18 months. Still, we’re very pleased with the existing positions in the Best Ideas portfolio and Dividend Growth portfolio and don’t expect to make any abrupt changes in light of this news.
Retail – Discount: BIG, DG, DLTR, FDO, FRED, PSMT
Related Firms: COST, WAG