Image Source: Dollar General Corporation – Fiscal 2020 Annual Report
By Callum Turcan
On August 26, Dollar General Corporation (DG) reported second-quarter earnings for fiscal 2021 (period ended July 30, 2021) that beat both consensus top- and bottom-line estimates. Dollar General updated its full fiscal year guidance in conjunction with its latest earnings report in a favorable manner, though investors were expecting more, and shares of DG fell moderately after the report was published. We continue to like Dollar General as an idea in the Best Ideas Newsletter portfolio, however.
Guidance Boost
Dollar General’s updated guidance calls for net sales growth of 0.5%-1.5% (versus its previous guidance calling for flat net sales at the midpoint) and a decline in its same store sales of 2%-3.5% (a smaller decline at the midpoint than its previous guidance) in fiscal 2021. Please note Dollar General had a banner fiscal 2020 in the wake of surging consumer staples (pantry stuffing) demand due to the coronavirus (‘COVID-19’) pandemic, and that on a two-year stack basis, its same store sales are expected to grow 13%-14% in fiscal 2021. During the company’s latest earnings call, management noted that Dollar General’s same store sales performance was the weakest in May and the strongest in July last fiscal quarter, and that Dollar General’s fiscal third quarter was “off to a great start.”
The retailer also increased the bottom end of its diluted EPS range (Dollar General now forecasts it will post $9.60-$10.20 in diluted EPS in fiscal 2021) and moderately raised its targeted share buybacks and capital expenditure expectations for this fiscal year versus previous guidance. Overall, this guidance boost was modest but still favorable given the environment as various headwinds are building for retailers, especially discount retailers. How the “delta” variant of the COVID-19 pandemic will impact its business remains to be seen, though Dollar General has been planning ahead and bulking up its inventories, something we will cover later in this article.
Hurdles
Supply chain and inflationary hurdles are beginning to weigh on Dollar General. Its GAAP revenues declined modestly year-over-year and its GAAP gross margin dropped ~80 basis points last fiscal quarter. Management cited higher transportation costs, product mix shifts, higher LIFO provisions (as goods are becoming more expensive), and increased inventory damages during its latest earnings call as factors that weighed negatively on Dollar General’s gross margin performance last fiscal quarter. The company’s lower revenues were largely the result of difficult year-over-year comparisons created by the COVID-19 pandemic, however.
Weaker gross margins along with inflationary pressures arising from higher retail wages and store occupancy costs played a key role in reducing the company’s GAAP operating margin by ~220 year-over-year in the fiscal second quarter. Sales of consumable products were up 2% year-over-year last fiscal quarter, though sales of seasonal, home products, and apparel products were all down year-over-year. This product mix shift weighed negatively on Dollar General’s gross margins as consumable product sales tend to carry lower margins than its other offerings. Higher inventory markups and reduced inventory shrink helped offset some of the headwinds Dollar General’s margins faced last fiscal quarter, but only to a degree.
Inventory Levels Flush
During the initial phases of the COVID-19 pandemic, Dollar General’s inventories were aggressively drawn down due to the “panic buying” and “pantry stockpiling” dynamics seen during this period. More recently, Dollar General has been building its inventories back up. As of July 30, 2021, Dollar General had a $5.3 billion merchandise inventory balance, up from $4.4 billion seen as of July 31, 2020.
Management recently noted that the firm “strategically pulled forward certain inventory purchases during the quarter, particularly in select non-consumable categories in anticipation of longer lead times” in the wake of the various supply chain hurdles the entire world is grappling with right now (such as the buildup of ships off the coast of California near the ports in Los Angeles and Long Beach, which are waiting to offload goods for US consumers). Furthermore, Dollar General noted that “(it was) pleased with (its) strong inventory position for the back-to-school shopping season,” and we appreciate the forward-thinking nature of the company’s management team.
The retailer generated $0.8 billion in free cash flow during the first half of fiscal 2021 which fully covered $0.2 billion in dividend obligations, though its $1.7 billion in share repurchases were largely funded by cash on hand during this period. Its free cash flows fell sharply lower year-over-year, though we emphasize that this was primarily due to balance sheet shifts related to the COVID-19 pandemic (the firm reported very favorable working capital movements in the same period last fiscal year).
Dollar General built up a large cash position during the initial phases of the COVID-19 pandemic and is now in the process of returning that capital to shareholders. This is primarily why the firm modestly increased its targeted share repurchases for fiscal 2021, up roughly $2.4 billion from $2.2 billion previously in conjunction with its latest earnings update. Please note Dollar General exited last fiscal quarter with a sizable but management net debt position of ~$3.8 billion, along with significant operating lease liabilities to be aware of.
Plans to Grow Non-Consumable Product Sales
Dollar General continues to invest in the business (it boosted its capital expenditure expectations for fiscal 2021 by ~$0.05 billion at the midpoint versus previous guidance during its earnings update) and opened over 500 net new stores during the first half of fiscal 2021, bringing its total to a tad under 17,700 by July 30, 2021. Management noted during the company’s latest earnings call that roughly three quarters of the US population is located within five miles of a Dollar General store.
The retailer has several key initiatives in the works that management provided some nice commentary on during the firm’s latest earnings call. For starters, Dollar General’s ‘Non-Consumable Initiative’ (‘NCI’) aims to grow the sales of its seasonal, home products, apparel products, and other non-consumable offerings by broadening and improving the product selection its stores. That process includes optimizing its store layout. As noted previously, these are products that generally carry higher gross margins than its consumable product sales.
Management recently noted that by the end of the fiscal second quarter, the NCI had been rolled out to over 8,800 of Dollar General’s stores. Additionally, management commented that this initiative “is contributing to an incremental 1% to 2.5% total comp sales increase in NCI stores, and a meaningful improvement in gross margin rate, as compared to stores without the NCI offering.” By the end of fiscal 2021, this initiative is expected to be rolled out to 11,000 stores and by the end of fiscal 2022, Dollar General aims to have completed the NCI rollout across all of its stores.
Another part of Dollar General’s strategy to grow its non-consumable sales involves the launch of its new store concept, pOpshelf, which focuses primarily on selling home décor, kitchenware, arts and crafts, and other non-consumable items at a low cost. Dollar General has rolled out over 15 of these store concepts so far and aims to bring 50 total pOpshelf locations online by the end of fiscal 2021. Management recently noted that “while still early, we remain extremely pleased with our results, which continue to exceed our expectations for both sales and gross margin” as it concerns the pOpshelf store concepts. Dollar General is also testing store-within-a-store concepts involving pOpshelf and its namesake stores, with plans to roll out 25 of these concepts by the end of fiscal 2021.
Margin Enhancing Initiatives
Pivoting here, Dollar General plans to improve its margin performance over the long haul through its DG Fresh initiative, which in short aims to bring more of its supply chain and logistics operations under its own roof. The company recently completed the rollout of DG Fresh and is now supplying frozen and refrigerated items from a dozen distribution facilities to its store base across the country.
Please note this initiative should also help Dollar General add more produce items to its stores over the long haul, though that was not why the DG Fresh initiative was embarked on originally. Dollar General currently offers produce across only a modest portion of its store base. The goal is to push that up to 10,000 stores in the years to come according to recent management commentary, and the firm’s DG Fresh initiative is also helping Dollar General expand its private label business. Looking ahead, adding produce to a greater number of its stores and bulking up its private label business should provide Dollar General with two powerful growth catalysts.
Dollar General continues to expand its cooler capacity, too. Management noted that the firm added over 34,000 cooler doors to its store base during the first half of fiscal 2021 and was on track to add roughly 65,000 cooler doors in fiscal 2021 to its operations. These coolers are expected to help Dollar General better keep its stores stocked with products its customer base wants and should enable a wider selection of products to be available in its stores.
Additionally, Dollar General is testing its larger 8,500 square feet store formats, which would be able to house a greater amount of cooler capacity. These larger store formats are expected to become the norm for the retailer’s new store locations going forward.
Digital and Tech Initiatives
On the technology front, Dollar General’s mobile app continues to grow in popularity. The firm ended the fiscal second quarter with 4 million monthly active users using its app, up 28% year-over-year. Dollar General’s data driven marketing platform, DG Media Network, was launched back in 2018 and continues to appeal to the retailer’s key brand partners according to recent management commentary.
The company is also steadily rolling out self-checkout options at its stores which were available in roughly 4,300 stores by the end of last quarter. By the end of fiscal 2022, Dollar General aims to have self-checkout options available across the “vast majority” of its store base.
Self-checkout options are part of Dollar General’s ‘Fast Track’ initiative which aims to “[increase] labor productivity in (its) stores, enhancing customer convenience, and further improving on-shelf availability.” Additionally, Dollar General notes this initiative aims to “[optimize] (its) rolltainers in case of pack sizes, resulting in the more efficient stocking of (its) stores.” Self-checkout options “provide customers with another flexible and convenient checkout solution, while also driving greater efficiencies for (its) store associates” according to recent management commentary.
We appreciate management’s detailed update on Dollar General’s various initiatives during the company’s latest earnings call, as these endeavors will play a key role in supporting the firm’s sales growth and margin expansion potential in the coming years. Ultimately, these initiatives will play a leading role in enabling the discount retailer to remain competitive in the hypercompetitive retail landscape and support its free cash flow growth trajectory over the long haul. Dollar General is spending a significant amount on these efforts via incremental SG&A expenses and meaningful capital expenditures, and we are big fans of these endeavors.
Concluding Thoughts
Dollar General is one of our favorite retailers out there. The company’s recent performance is contending with the banner year that Dollar General put up in fiscal 2020, making year-over-year comparisons noisy. We continue to view Dollar General’s free cash flow growth outlook quite favorably, aided by the various initiatives mentioned above. After bulking up its inventories, Dollar General is ready for the back-to-school and holiday shopping season. We continue to view the discount retailer’s capital appreciation upside quite favorably, and Dollar General’s dividend offers incremental upside here as well. Shares of DG yield a modest ~0.8% as of this writing.
To read more about our thoughts on the retail industry, please check out this article here covering the great news Dividend Growth Idea Dick’s Sporting Goods Inc (DKS) just announced during its latest earnings update.
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Callum Turcan does not own shares in any of the securities mentioned above. Chipotle Mexican Grill Inc (CMG), Dollar General Corporation (DG), Domino’s Pizza Inc (DPZ) and The Walt Disney Company (DIS) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Dick’s Sporting Goods Inc (DKS) and Home Depot Inc (HD) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Vanguard Consumer Staples ETF (VDC) is included in Valuentum’s simulated High Yield Dividend 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.