Description

We believe that Dollar General (DG) shares are attractive at current levels.  The company is largest dollar store retailer with a convenient small-box format offering everyday low priced consumables and a variety of general merchandise. We view the current valuation of ~17x NTM P/E and a 5% FCF yield as attractive given the consistency of the business model over the long-term and limited downside risk.  FY2018 should represent the 29th consecutive year of positive DG same-store sales growth. DG should compound EPS and FCF per share at a low DD CAGR over the long-term and generate strong returns for shareholders.  

Below is a brief overview of the business.  Prior VIC write-ups also do an excellent job describing the business and strategy.  

• Over 15,277 stores in 44 states

• Broad selection of merchandise, including consumables, seasonal items, home products and apparel

• Price points of $10 or lower

• 80% of SKUs at $5 or less

• 7,400 square foot stores

• 75% of our stores are located in towns of 20,000 or fewer people

• Sales by Category

• Consumables - 76.9%

• Seasonal - 12.1%

• Home Products - 6.0%

• Apparel - 5.0%

• 129,000 employees

• 5% of products were directly imported in 2017

• Founded in 1939

• Largest store concentrations are in rural areas of the Southern, Southwestern, Midwestern, and Eastern U.S.

• Average shopper has a household income of ~$40,000

• 75% of the population within 5 miles of a DG store

We have a favorable long-term outlook for the discount retail industry.  The company has a long term track record of growth through economic cycles including strong performance in recessions as consumers trade down to more affordable retail concepts.  DG’s EPS CAGR from 2007 to 2017 is over 30% and delivered positive same store sales in each year. The business is relatively insulated from e-commerce competition and should continue to perform in line with long term revenue growth trends.  The small basket size, fill-in trip nature of purchases, large percentage of cash transactions (~50%) and low value items that aren’t good candidates for shipping all help to limit e-commerce competition. The price advantage for DG is a ~20% discount relative to traditional grocery and a ~40% discount to drug retail driven by a lean cost structure.  Over the long-term, we believe that this format is well positioned to take share from other retail formats. The dollar store format accounts for just ~5% of the U.S. retail market.

We expect the company to grow its square footage in the MSD range over the next several years with continued implementation of the company’s disciplined real estate criteria (new store productivity, actual sales performance, average returns of over 20%, cannibalization, and the payback period).  The management team, led by CEO, Todd Vasos, is among the best in the industry and that the company excels in real estate. Management estimates a long-term opportunity for 12,000 or 13,000 additional U.S. dollar stores. In addition, we expect the business to deliver LSD+ same store sales, in line with the long-term average.  Operating margin should be flat to up modestly with potential cost headwinds offset by several gross margin expansion initiatives as well SG&A leverage. The company is likely to use its substantial FCF generation of over $1.2 bil. to primarily repurchase shares. We estimate that the company can repurchase about $1 bil. of its shares annually and reduce the share count by ~3%.  Overall, we believe that DG is an attractive risk/return opportunity with the business delivering low double digit EPS growth in all economic environments.

The company has several initiatives which we believe will continue to support solid same store sales growth in the LSD+ range.  Continued store remodels (1,000 in 2018) are driving a 4% to 5% same store sales boost at DG. Cooler expansion continues to be an important sales growth initiative, particularly in mature stores.  In FY18, the company has installed 20,000 cooler doors across its mature store base with a high ROI. Queue lines are being optimized to drive increased sales and ~7,500 stores have now been optimized.  Recently, DG launched its Better-for-You initiative, which offers expanded healthier food options at affordable prices to consumers. This initiative is off to a strong start (in 2,700 stores) and is in line with consumer trends.  DG is taking advantage of the Toys-R-Us bankruptcy to offer more toys including LEGO toys in all stores. The DG GO! App (~20,000 active monthly users) allows customers to use their phone to scan items as they shop and then skip the checkout line by using the DG GO! kiosk in ~250 stores.  DG also has a digital coupon program in which it has 15 mil. subscribers with more than 700 mil. coupons used in 2018. We believe these initiatives continue to add convenience and value for consumers, leading to more traffic at DG stores and sustained same store sales growth.

Some of the key gross margin expansion initiatives being utilized by the company include reduction in shrink through enhanced surveillance, increasing owned tractors (to over 200 in 2018) to reduce transportation costs, expanding PL penetration from the 20% to 25% range currently and more direct sourcing from international markets.  We note that DG has done better than many of its peers in terms of managing through an inflationary environment in FY2018.

Risks

Consumables retail is an inherently competitive industry.

Cost inflation (merchandise/tariffs, freight and labor) could be a greater than expected headwind.

Strong economic growth could cause dollar stores to underperform other more cyclical retailers.  

Catalyst

Continued double digit EPS and FCF per share growth

More challenging macro environment