Description

Dollar General Corporation (Ticker: DG) is a large cap discount merchandise retailer operating in 46 states, with a concentration in rural and suburban areas and the southern US, and is the largest discount retailer in the US by store count, with 17k+ stores.

DG is cheap, because it had transitory earnings and cash flow boost from lockdowns during the pandemic, as consumers shopped closer to home; some investors believe the stock will underperform as it hits tough YoY comps. We think DG’s longer-term growth trends are intact, and we argue this has created a reasonable entry point for a franchise that has compounded at high rates for many years.

LOW PRICES / CONVENIENCE

DG competes by offering national and private brand products at lower prices (<$10 or less) than found in competing grocery, drug and other discount retailers. It targets lower income ($35k-$40k), thrifty consumers, where they live, and attracts them with low prices, smaller packaging, and convenient access. Unlike when you go to Costco to buy in bulk, lower-income DG shoppers tend to buy in small quantities, as they may not have the disposable income to devote to bulk purchases. Many of these consumers have limited access to online retail access, and so rely on DG to meet many essential needs. DG undercuts even Amazon on prices for staples like laundry detergent or household cleaning items such as sponges. This makes DG the ideal one-stop shop for a wide range of everyday necessities.

SMALL-BOX RURAL REAL ESTATE

DG employs a small-box real estate approach, with stores averaging approximately 7,500 square feet. Consumers can get in and out quickly, and stores are easy to navigate. By contrast, a Walmart might be on the order of 100k square feet, with Supercenters of >250k square feet. DG has grown by reaching into geographic areas that Walmart cannot reach, and purposely locates its stores at least 15-20 miles from such larger competitors. Indeed, underserved DG neighborhoods may not even have a competing full-service grocery store. DG locates stores in small, lower-income, rural towns, within 5 miles of approximately 75% of the US population.

DG has launched two new store formats: Dollar General Plus, with selling space of 8,500 SF for, and Dollar General Traditional Plus, with selling space of 9,500 SF (mainly due to a higher cooler count), which are both larger than the 7,300 SF found in traditional stores. These new formats have been outperforming on volume and comp sales. The new Dollar General Plus format is the prototype for most new stores going forward.

DG has plans to open ~1,000 stores this year, consistent with the past rate of new store openings. The company estimates there are approximately 13,000 additional small-box store opportunities in the US, and 4,000 additional opportunities for other formats, representing a healthy growth runway.

LEAN OPERATIONS

DG offers fewer products than does Walmart, with ~10k SKUs versus the ~60k found in Walmart. DG excels at finding items that other retailers cannot seem to sell, buying them in bulk, and offering them at a very low price per unit. Smaller stores and fewer SKUs translate to a simpler operation requiring fewer staff, and with fewer restocking headaches. Limited SKUs also mean DG has better bargaining power with suppliers for select merchandise. The company’s “Fast Track” program is an effort to enhance convenience, and on-shelf availability through stocking efficiencies, as well as added labor efficiencies, through self-checkout.

MARGINS

DG has maintained steady gross margins of 30%-31% in each of the past five years, indicating cost discipline and pricing power.

DG’s largest merchandise category, accounting for approximately 77% of sales, is consumables, which tend to be grocery staples and household essentials, such as paper and cleaning products, packaged foods, perishables, snacks, health and beauty, pet supplies, and tobacco. These are things you might find at a drug, grocery store, or competing discount retailer, where competition is fierce, and margins low.

Over time, this category has been growing, which has been a margin headwind. DG’s strategy to offset this trend has been to expand into higher-margin non-consumable categories.

The company’s non-consumables initiative (NCI) aims to broaden its non-consumable selection, including home, domestics, and housewares, which has rolled out to a third of DG’s stores, and DG plans to expand the offering to almost two-thirds of stores this year.

DG has also accelerated its "pOpshelf" in-store offering, an initiative targeting higher-margin non-consumables, and wealthier clients, with items priced very low, at under $5. Although DG has traditionally avoided foods with short shelf life and perishables, DG Fresh is another initiative involving a self-distribution model for frozen and refrigerated products, which drives high initial markups and introduces new products, with a longer-term goal of adding produce to most stores.

MIDDLE-CLASS INCOME TRENDS

The middle class is shrinking and has suffered a loss in share of the nation’s aggregate income over recent decades. A recent Pew Research Center study notes that the share of adults who live in middle-income households has fallen from 61% in 1971 to 51% in 2019; similarly, from 1970 to 2018, the middle class’s share of aggregate income fell from 62% to 43%. As DG’s CEO put it, “the economy is continuing to create more of our core customer.” If you believe, as we do, that this trend will continue, and are looking for a way to get some positive exposure to this dynamic, and chance to benefit from it, this strikes us as a reasonable way to do so.

COUNTER CYCLICALITY

When shoppers are economically squeezed, they shop for value. Thus, DG tends to be defensive, and enjoys counter-cyclical benefits: when the economy struggles, DG’s business flourishes as unemployed consumers and stressed households turn to discounters like DG for basic needs. This occurred in spades for DG during the pandemic.

FINANCIAL STRENGTH

2020 was a fantastic year for DG, in which its FCF rose by triple digits versus 2019. But over the prior 4 years, from 2015 to 2019, DG’s FCF had also grown significantly, having compounded at a rate of 16%. Similarly, Book Value per share has compounded at an 8% rate over the past 5 years. DG has increased its dividend at a 10% CAGR over the past 5 years. While DG’s ROE was 40% last year, the company averaged >20% ROE for each of the preceding 5 years. The company maintains an investment-grade credit rating, with EBITDA/debt of approximately 3x. We believe these metrics indicate that DG is a strong, financially well-managed, growing company.

SHARE REPURCHASES

DG has reduced its share count by 16% over the past five years, during which time it repurchased $7.5 billion in stock. The company is targeting another $1.8 billion of buybacks this year.

SUMMARY

DG has stated its ambition is to grow EPS at double-digit rates in the long run. We think that is a reasonable ambition. Last year, DG achieved its 31st consecutive year of same-store sales growth, and today it trades at 16X EV/EBITDA, and a P/E of 20. In today’s market, where this valuation is near the cheapest 10% of tradeable stocks in our tradeable universe (> ~$3bn mkt cap), we think solid growth at this price qualifies as cheap for a long-term compounder like DG. We believe DG’s proven model of offering consistently low prices, via a small-box model that caters to rural, low-income consumers, is a formula that should continue to succeed.

Catalyst

-Economy creates more core customers

-New store runway, rollout of new store formats

-Margin success with non-consumables, pOpshelf, DG Fresh

-Share repurchases, growing dividend