Image Source: Valuentum
By Brian Nelson, CFA
On December 1, Dollar General Corp (DG) reported mixed third-quarter fiscal 2022 results where revenue came in slightly better than expectations on the back of same-store sales expansion of 6.8%, while GAAP earnings per share came up a bit short relative to the consensus estimate. Dollar General remains a “position” in the simulated Best Ideas Newsletter portfolio, and our fair value estimate stands at $250 per share.
Many consumers are looking for ways to stretch their budgets in the current inflationary economic environment. That means cutting back on some discretionary items, but also looking for key deals across the retail landscape. Dollar General operates within a niche in the industry similar to the likes of Dollar Tree (DLTR) and Five Below (FIVE), where it seeks to attract the value-oriented customer.
Dollar General offers consumers merchandise from established brands as well as private-brand products at prices that are typically under $10. What has made Dollar General a strong consideration for long-term investors has been its consistency. Excluding 2021, the company has achieved more than 30 consecutive years of positive same-store sales performance. The company faced tough comparisons in 2021 given COVID-19 stimulus-driven expenditures by consumers.
Dollar General offers a trade down option for consumers of Walmart Inc. (WMT) and Target Corp. (TGT) that may not want to spend up to buy in bulk at Sam’s Club or Costco Wholesale (COST). Dollar General’s stores offer both value and convenience and tend to do very well in small markets where there may be limited alternatives for customers to pick up consumables, seasonal items, and home products. The company also competes effectively in larger markets, where consumer choices may be abundant.
Here’s where Dollar General carves out its niche, from its 10-K:
Everyday Low Prices on Quality Merchandise. Our research indicates that we offer a price advantage over most food and drug retailers and that our prices are competitive with even the largest discount retailers. Our ability to offer everyday low prices on quality merchandise is supported by our low-cost operating structure and our strategy to maintain a limited number of items per merchandise category, which we believe helps us maintain strong purchasing power. We offer nationally advertised brands at these everyday low prices in addition to offering our own private brands at substantially lower prices.
Convenient Locations. Our stores are conveniently located in a variety of rural, suburban and urban communities. We seek to locate our stores in close proximity to our customers, which helps drive customer loyalty and trip frequency and makes us an attractive alternative to large discount and other large-box retail and grocery stores.
Time-Saving Shopping Experience. We strive to provide customers with a highly convenient, easy to navigate shopping experience. Our small-box stores make it easier to get in and out quickly, and our digital tools and offerings help drive even greater convenience and additional access points. Our product offering includes most necessities, such as basic packaged and refrigerated or frozen food and dairy products, cleaning supplies, paper products, health and beauty care items, greeting cards and other stationery items, basic apparel, housewares, hardware and automotive supplies, among others. Our convenient hours and broad merchandise offering allow our customers to fulfill their requirements for basic goods and minimize their need to shop elsewhere.
During its third quarter of fiscal 2022, net sales advanced 11.1%, to $9.5 billion, while operating profit advanced at roughly a similar pace (6.8%), to $735.5 million. Diluted earnings per share increased 12%, to $2.33. Management noted Dollar General experienced a modest increase in customer traffic and strong performance with respect to average ticket prices while it took share from rivals during the period. Distribution and transportation costs weighed on profitability, but operating profit and earnings per share performance was resilient, in our view.
Dollar General’s free cash flow fell considerably on a year-over-year basis for the 39 weeks ended October 28, as merchandise inventories ballooned 28.4%, to $7.1 billion. We’ve been seeing inventories increase across the retail landscape but we’re a bit more concerned when this happens at bargain retailer Dollar General, which should be clearing shelves at discount prices, than at a more discretionary and pricier retailer such as Nike (NKE), which may have more trouble getting consumers to open their pocketbooks.
Looking to its fourth quarter of fiscal 2022, management noted that internal supply chain issues will result in higher-than-expected gross margin pressures, but diluted earnings per share that is expected in the range of $3.15-$3.30 per share for the fourth quarter still implies high-single-digit growth on a year-over-year basis. Same-store sales growth is expected to be in the range of 6%-7% for the fourth quarter of 2022. We’ll be paying close attention to how free cash flow performs to end the fiscal year, given inventories and the considerable increase in capital spending.
Concluding Thoughts
Though comparable store sales have been consistent over the years at Dollar General, we think the concept is getting “tired” as inflation eats into its value offerings. Inventories are ballooning at the firm and internal supply chain problems will eat into earnings during the fourth quarter of fiscal 2022, while the firm continues its aggressive store expansion efforts (with 1,050 new stores expected in fiscal 2023). Dollar General remains an idea in the simulated Best Ideas Newsletter portfolio, but it could become a source of “cash” if inventories and free cash flow generation become a bigger issue.
Tickerized for DG, DLTR, FIVE, WMT, TGT, COST, BJ, LOTS, KR, WBA, CVS, RAD
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But how, you will ask, does one decide what [stocks are] “attractive”? Most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth,”…We view that as fuzzy thinking…Growth is always a component of value [and] the very term “value investing” is redundant.
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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE, RSP. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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