Image Source: Dollar General Corporation – Fiscal 2020 Annual Report
By Callum Turcan
On December 2, Dollar General Corporation (DG) reported third quarter earnings for fiscal 2021 (period ended October 29, 2021) that matched consensus top-line estimates and beat consensus bottom-line estimates. The discount retailer also once again raised its full-year guidance for fiscal 2021, which we will cover in just a moment. For reference, please note that Dollar General’s fiscal years end in late-January or early-February.
We will start off by stressing that Dollar General put up banner performance in fiscal 2020 (period ended January 29, 2021) when its same-store sales boomed higher by over 16% and its GAAP net revenues grew by almost 22% on an annual basis. Its performance in fiscal 2021 is facing tough year-over-year comparisons due to the “panic” shopping spree brought on the by early days of the coronavirus (‘COVID-19’) pandemic, though Dollar General has continued to put up stellar results even as that tailwind faded.
We continue to like Dollar General in the Best Ideas Newsletter portfolio, and the top end of our fair value estimate range sits at $266 per share of DG. Furthermore, its modest dividend policy offers incremental upside to its substantial capital appreciation potential. As of this writing, shares of DG yield ~0.8%. Due to the discount retailer’s stellar free cash flow generating abilities and promising growth runway, there is ample room for its dividend to grow going forward.
Earnings Update
Last fiscal quarter, Dollar General’s GAAP revenues grew by 4% year-over-year to reach $8.5 billion. Sales growth at its consumables (up 5%), seasonal (up 1%), and home products (up 7%) offerings offset an 11% drop in its apparel sales. Factory closures and other disruptions in Southeast Asia due to lockdowns related to the COVID-19 pandemic weighed negatively on global apparel production this year, which hurt Dollar General along with various other apparel retailers. However, those headwinds have eased up somewhat in recent weeks.
Dollar General exited the fiscal third quarter with $5.3 billion in merchandise inventories (up 1% on a year-over-year basis). Though inventories were down marginally year-over-year on a per-store basis, Dollar General should still be able to meet robust consumer demand during the current holiday shopping season.
New store openings were key to supporting Dollar General’s sales growth last fiscal quarter as its same-store sales fell by 0.6% year-over-year. The company’s GAAP gross margin shrank by over 55 basis points year-over-year last fiscal quarter, hitting ~30.8%. Its GAAP gross margins were negatively impacted by an unfavorable product mix shift (higher lower-margin consumable sales), higher transportation expenses, a higher LIFO provision, and an increase in inventory damages (possibly due to ongoing logistical hurdles combined with the effects of the holiday rush). Higher inventory pricing markups and a reduction in inventory shrink (usually means lower theft) helped offset those headwinds to its gross margin performance, to a degree.
Rising SG&A expenses, primarily a product of higher labor and rent expenses, combined with headwinds facing its gross margin performance saw Dollar General’s GAAP operating margin fall over 160 basis points year-over-year in the fiscal third quarter, hitting ~7.8%. The firm’s GAAP operating income dropped 14% year-over-year, declining to just under $0.7 billion. Expenses related to COVID-19 shifted lower year-over-year last fiscal quarter. Dollar General’s GAAP diluted EPS came in at $2.08 in the fiscal third quarter, down 10% year-over-year. The company’s outstanding diluted share count shrank 6% year-over-year last fiscal quarter due to Dollar General’s sizable share repurchases.
During the first three quarters of fiscal 2021, Dollar General generated over $1.4 billion in free cash flow and spent $0.3 billion covering its dividend obligations along with another $2.1 billion buying back its stock. The company exited the fiscal third quarter with $3.6 billion in net debt with no short-term debt on the books, though Dollar General has sizable current and non-current operating lease liabilities to be aware of.
On December 1, Dollar General’s board increased the company’s authorized share buyback capacity up to $2.0 billion (which stood at $0.6 billion at the end of the fiscal third quarter). In moderation, share buybacks can be a good use of capital, though we would prefer that Dollar General also pare down its net debt load over time as well. Given its stellar free cash flow generating abilities and ample liquidity on hand ($0.5 billion in cash and cash equivalents at the end of the fiscal third quarter), we view Dollar General’s net debt load and future dividend obligations as manageable.
During the discount retailer’s latest earnings call management noted (emphasis added):
“Our capital allocation priorities continued to serve us well and remain unchanged. Our first priority is investing in high return growth opportunities, including new store expansion in our strategic initiatives. We also remain committed to returning significant cash to shareholders through anticipated share repurchases, and quarterly dividend payments, all while maintaining our current investment grade credit rating in managing to a leverage ratio of approximately 3x adjusted debt to EBITDA.” — John Garratt, EVP and CFO of Dollar General
Guidance Boost
The discount retailer raised its full-year guidance (again) for fiscal 2021 in conjunction with its latest earnings report. Dollar General boosted its sales growth forecast to 1.0%-1.5% (up from 0.5%-1.5%) and raised its diluted EPS guidance to $9.90-$10.20 (up from $9.60-$10.20 previously) for the current fiscal year. The firm also reduced its expected same-store sales decline to 2.5%-3.0% (versus a decline of 2.5%-3.5% previously) for fiscal 2021.
Please note that Dollar General also boosted its full-year guidance for fiscal 2021 back when reporting its first and second fiscal quarter earnings reports. When publishing its fourth quarter of fiscal 2020 earnings report, Dollar General expected its net sales would decline 2% in fiscal 2021 or at best come in flat, while its same-store sales were expected to drop by 4%-6% and its diluted EPS was expected to come in at $8.80-$9.50. The company’s outlook has improved considerably since then.
When reporting its fourth-quarter fiscal 2020 earnings update, Dollar General forecasted that it would spend $1.05-$1.15 billion on capital expenditures and another $1.8 billion on share repurchases in fiscal 2021. Now Dollar General intends (as of the third quarter of fiscal 2021) to spend $1.1-$1.2 billion on capital expenditures and another $2.4 billion on share purchases in fiscal 2021.
Strategic Announcements
We view Dollar General’s growth runway quite favorably and appreciate the numerous strategic initiatives it currently has underway. In September 2021, Dollar General expanded into its 47th US state by beginning construction at a new store in Idaho, which is set to be operational by the spring of 2022. Back in April 2020, Dollar General opened its first store in Washington state, which represented its 46th US state to operate in.
One thing that caught our eye during Dollar General’s latest earnings report was the announcement that it would enter Mexico. Within Dollar General’s fiscal third-quarter earnings press release, its CEO Todd Vasos was quoted as saying that “we are also excited to announce our plans to expand our footprint internationally for the first time, with plans to open up to ten stores in Mexico by the end of fiscal 2022, as we continue to lay the foundation for future growth.” This represents a major strategic change by Dollar General, though one that makes sense.
Dollar General’s core business model is built around operating in small cities and towns with populations of 20,000 or less, regions that are arguably underserved by major retailers and difficult for e-commerce firms to operate in. While Dollar General intends to continue growing its physical store footprint in the US going forward, eventually it would run out of new store opening opportunities that still fit in with its core business model. Expanding into Mexico further extends Dollar General’s growth runway. Here is what Dollar General’s management team had on say on the issue during the company’s latest earnings call (moderately edited, emphasis added):
“We are also now at the early stages of plans to extend our footprint into Mexico, which will represent our first store locations outside the continental United States. We believe Mexico represents a compelling expansion opportunity for Dollar General given [its] demographics and proximately — proximity to the U.S and we are confident that our unique value and convenience proposition will resonate with the Mexican consumer. While our initial entry into Mexico is focused on piloting a small number of stores in 2022, [what] we plan today will ultimately turn into additional growth opportunities in the future.” — CEO of Dollar General
Looking ahead, Dollar General “plans to execute 2,900 real estate projects in fiscal year 2021, including 1,050 new store openings, 1,750 store remodels, and 100 store relocations” and “for fiscal year 2022, the Company plans to execute 2,980 real estate projects, including 1,110 new store openings, 1,750 remodels, and 120 store relocations” according to its latest earnings press release. For reference, Dollar General had over 17,900 stores in operation at the end of the third quarter of fiscal 2021, up from just below 17,000 store locations at the end of the third quarter of fiscal 2020.
Part of its strategy in this area, beyond expanding into new US states and the Mexican market, is through the launch of its new store concept pOpshelf (announced in October 2020). In short, pOpshelf is Dollar General’s way to catering moderately more affluent consumers (households in the $50,000 – $125,000 per year range) located in urban/suburban/exurban regions, as compared to the more working class households in rural areas that has traditionally represented its core customer focus.
According to Dollar General, its pOpshelf store concept has performed quite well of late. During the firm’s latest earnings call its CFO noted that “we continue to be very pleased with the performance of our pOpshelf stores, which have far exceeded our expectations for both sales and gross margin.”
By fiscal 2025, Dollar General aims to open ~1,000 pOpshelf stores. While there is a substantial degree of operational execution risk, we are intrigued by the new store concept and appreciate that Dollar General first proved the concept was viable by launching a few dozen stores before committing to a big expansion project. The company’s CFO also noted during the firm’s latest earnings call that “we anticipate year one annualized sales volumes for our current locations to be between $1.7 million and $2 million per store and expect the initial average gross margin rate for these stores to exceed 40%,” highlighting the potential uplift these store concepts could provide Dollar General’s company-wide operations (keeping in mind its GAAP gross margin came in just below 31% last fiscal quarter).
Other Initiatives
Dollar General has various other strategic initiatives in the works that involve improving its distribution operations (reducing the need for more expensive third-parties logistics services), expanding its higher margin non-consumable sales, adding additional coolers to its stores, adding more fresh produce to its stores along with other products, upgrading its e-commerce presence and in-store digital capabilities (such as adding self-checkout kiosks), along with other endeavors. We covered these initiatives extensively in our August 2021 article Best Idea Newsletter Portfolio Idea Dollar General Provides Key Update for Investors that we strongly encourage our members to check out (link here).
Dollar General has many other initiatives underway, too. Here are some of its recent updates from its latest earnings call (emphasis added):
“Turning now to DG Fresh, which is a strategic multi-phase shift to self-distribution of frozen and refrigerated goods. As a reminder, we completed the initial rollout of DG Fresh across the entire chain in Q2 and are now delivering to more than 18,000 stores from 12 facilities. The primary objective of DG Fresh is to reduce product costs on our frozen and refrigerated items. And we continue to be very pleased with the savings we are seeing as DG Fresh remains a meaningful contributor to our gross margin rate.
Another goal of DG Fresh is to increase sales in these categories. And we are very happy with the performance on this front. As overall comp sales of our frozen and refrigerated goods outperformed all other product categories in Q3, even against a difficult prior year sales comparison. Going forward, we expect to realize additional benefits from DG Fresh as we continue to optimize our network, further leverage our scale, deliver an even wider product selection and build on our multi-year track record of growth in cooler doors and associated sales.
With regards to our cooler expansion program, during the first three quarters, we added more than 52,000 cooler doors across our store base. In total, we expect to install approximately 65,000 additional cooler doors in 2021, the majority of which will be in high capacity coolers.
Turning now to an update on our expanded health offering, which consists of about 30% more feet of selling space and nearly 400 additional items as compared to our standard offering. This offering was available in nearly 800 stores at the end of Q3 with plans to expand to approximately 1,000 stores by year-end. Looking ahead, our plans include further expansion of our health offering with the goal of increasing access to basic health care products and ultimately services over time, particularly in rural America.” — Jeff Owen, COO of Dollar General
Back in July 2021, Dollar General announced that it had hired its first chief medical director, and we now have a slightly better idea of what the company’s efforts regarding its healthcare push might be. Within that press release, the firm noted its effort in this area “will include an increased assortment of cough and cold, dental, nutritional, medical, health aids and feminine hygiene products across many of its Dollar General stores.” We are keeping a close eye on Dollar General’s healthcare-related initiatives. Dollar General has been testing out larger store concepts (in terms of square feet of retail space) which is helping set the stage for its efforts here.
Concluding Thoughts
We are big fans of Dollar General. The discount retailer has several big initiatives underway to extend its growth runway while boosting per store sales and enhancing its margins. Shares of DG have been treading water over the past few months after surging during the 2020 calendar year, though we still room for significant capital appreciation upside potential going forward. The company is a tremendous free cash flow generator, and we like shares of DG as an idea in the Best Ideas Newsletter portfolio.
Dollar General’s 16-page Stock Report (pdf) >>
Dollar General’s Dividend Report (pdf) >>
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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.