Finance Stock Report

Dollar General (NYSE: DG)

Will Allen, Chase Dollar, and Leah Haverkos

Business Description

Dollar General Corporation is a discount retailer in the

United States. It offers a selection of merchandise, including

consumable, seasonal, home products and apparel. The

Company’s consumables category includes paper and cleaning

products; packaged food; perishables (such as milk, beer and

wine); snacks; health and beauty; pet, and tobacco products. Its

seasonal products include decorations, toys, batteries, stationery,

prepaid phones and accessories, and home office supplies. Its

home products include cookware, craft supplies and kitchen, and

bed and bath soft goods. Its apparel products include casual

everyday apparel for all people. Dollar General sells brand-name

products from manufacturers such as Proctor & Gamble,

Kimberely-Clark, Unilever, Kellogg’s, General Mills, Nabisco, Hanes, PepsiCo, and Coca-Cola.

The fast-growing retailer boasts more than 13,000 discount stores in some 40 US states,

mostly in the South, East, the Midwest. It generates about 76% of its sales from consumables, and

12% from seasonal items. The rest of sales come from household products. Dollar General targets

low, middle, and fixed-income shoppers pricing items at $10 or less. Dollar General operated nearly

12,600 stores in the 43 US states in 2015. About 10% of its stores are in Texas and another 20% are

spread across Florida, Georgia, Ohio and North

Carolina.

Dollar General’s massive stores network is supported by 13 distribution centers that are

strategically located throughout it geographic footprint; it owns several trademarks, including Dollar

General, Dollar General Market, Colvery Valley, DG, DG Deal, Smart & Simple and many more. -

L.H.

Industry Overview

The basic consumer discount goods market is exposed to a large number of macroeconomic

factors; those being: unemployment rate, underemployment rate, wage rate, fuel prices, changes to

government assistance programs and more. Customers are also affected by increases in rent and

health care expenses, as these generally take up a large part of their income. Increasing poverty rate

is good for the industry as more consumers are looking for discounted item. Even though this

industry targets lower income individuals, the consumer pool for the industry has recently expanded

to middle-class shoppers and even some high income consumers. The number of heads of

households shopping at dollar stores under 35 years-old earning more than $100,000 a year

increased 7.1% between 2012 and 2015, compared to 3.6% at all retail store, according to Nielsen.

Around 29% of millennial dollar store consumer earn over $100,000 annually and accounted for

about 25% of sale at those stores, according to market research firm NPD’s Checkout tracking. -

L.H.

Competitive Position

Dollar General operates in a competitive space, but has seen very steady growth. For

example, the company has enjoyed 27 years of consecutive same store sales growth. Dollar General

currently holds 36.4% of the market share in the discount goods industry and expected to continue

to grow this number. As explained further below, Dollar General enjoys healthier margins and same

store sales growth, which should help to capture market share in the future.

Dollar Tree

Dollar Tree is perhaps Dollar General’s main competitor, with 29.2% of market share in the

discount goods space. They operate under a very similar business model to Dollar General, with

items under $5 being their primary focus. Dollar Tree used to be a much smaller player, but they

recently acquired Family Dollar, which essentially doubled their size. However, this acquisition has

proven to be a drag on Dollar Tree as a result of a lack of performance in the Family Dollar

segment. Family Dollar branded stores operate at lower margins and same store sales growth is

lackluster. Also, what separates Dollar General from both Dollar Tree and Family Dollar is the

cleanliness of their stores, friendliness of employees, and the strength of their stock keeping units.

Because of this, our team sees Dollar Tree foregoing market share to Dollar General.

Walmart

Conventionally, Walmart is not a direct competitor with Dollar General. However, over the

past couple of years, Walmart has begun to branch into the small-box retail segment with

experimental stores. Despite this adaptation, Dollar General enjoys several competitive advantages

over Walmart that will aid them in the long run. First, Walmart has attempted to implement “small-

box” style stores that are around 15,000 square feet. However, this is double that of an average

Dollar General store. This will increase operating costs and put pressure on these stores to compete

with Dollar General. Furthermore, Walmart recently increased minimum wage to $10, which will

furthermore add pressure to these stores and increase their operating costs significantly. But,

Walmart recently closed all 102 of their Walmart Express stores and Dollar General purchased their

41 best locations. Lastly, Walmart is being crushed by Amazon in the e-commerce space. Dollar

General has a small e-commerce presence, and is more immune to this threat. With the demographic

customers that Dollar General is focusing on, there is little possibility that Dollar General shoppers

will order everyday items on Amazon.

Target

Target operates as a much larger general merchandise retailer and is not really a direct

competitor to Dollar General. They are much more of a “large-box” retailer with larger stores than

Dollar General’s “small-box” model. The company offers products at a slightly higher price point

and is not focused on the same demographic as Dollar General. They may, however, be a threat due

to their strong presence on the e-commerce front.

To wrap up their competitive position, one can also see Dollar General operates at a higher

Operating Margin and Profit Margin than all of their competitors. In categories where they do not

have the highest margin overall, they are very close to it. - C.D.

Investment Positives

Shareholder friendly capital allocation

The Dollar General management team is currently in the process of repurchasing $5.0B worth of

shares, with $769.6M of that plan remaining as of August 4, 2017. The share repurchase program

began on September 5, 2012 with an initial $500M worth of shares planned, but it was eventually

extended to up to $5B in August 2016. In addition, management is putting their excess capital to

work by opening 1290 stores this year. They’re able to do this because they have an average store

payback period of 1.7 years, which is extremely short. Due to their industry leading ROIC of 14.17%

(DLTR = 9.21%), Dollar General is able to effectively put their capital to work in the best interest

of shareholders. - W.A.

Proven Business Model

Over the years, Dollar General has encountered competition from many big name companies such

as Walmart. For example, according to USATODAY, Walmart closed all of their small-box Walmart

Express stores in 2016 to shift their full focus to their supercenters and E-commerce. This was a

result of competition from Dollar General, as well as Walmart not knowing how to operate in a

store format where they had to be more selective in their product mix. This is something that Dollar

General specializes in, and this is why they are the leader in the industry. Also, one part of society

that Amazon is having difficulty breaking into is the lower class consumer market. This is because

Dollar General has positioned their stores 3-5 miles away from the majority of their customers, so

Amazon Prime does them basically no good when they need something quick, even if Amazon

Prime is offered at a lower rate for low-income consumers. - W.A.

Recession-Proof Business

While the majority of businesses struggle during an economic downturn or recession, Dollar

General is one of the few companies that has a business model that allows them to thrive during

tough times. For example, when consumers have a lot of disposable income, they’re less frugal with

their spending, and they may be less inclined to go to a dollar store to get their goods. On the other

hand, when consumers have limited disposable income, they’re more likely to go to Dollar General

because the goods are cheap and good quality for the price. As seen in the chart below, in 2008-2009

when the United States suffered tough economic times, Dollar General same store sales growth was

9.0% and 9.5, respectively. Also, net sales and sales per square foot continued to grow at great rates.

- W.A.

Investment Risks

Continued Price Wars

Dollar General operates in a very competitive space with giants like Walmart, Target, and

Dollar Tree. As a result, these companies continuously attempt to undercut each other on prices in

order to win market share. This pricing pressure can put a damper on Dollar General’s margins,

which are already sensitive due to the discount nature of their products. According to Value

Investors Club, much of this pricing pressure comes from Walmart, which announced they would

be willing to take a hit in their net income in order to win market share.

Slowing in same store sales growth

Dollar General has enjoyed 27 consecutive years of same store sales growth. However, it has

slowed in recent quarters. Because the stock trades according to same store sales growth more so

than earnings or other metrics, a significant decline could have a large effect on their stock price.

However, we see this as one reason why the stock is undervalued. Put simply, there has been an

overreaction to slower comps growth. Management believes any issues associated with this are

transitory in nature and expects increases in growth in the future. This will be aided by an end to

food deflation, which is expounded upon further in the next point.

Food price deflation continues

In the past year or so, the industry has been hurt by food deflation. Specifically, food

outputs. If this continues, it will negatively impact gross margins and be a headwind for Dollar

General. However, according to their CEO in the 2Q17 earnings call, there “signs of commodity

deflation waning.” Because of this, Dollar General may see some margin expansion or just an end to

margin contraction. However, it continues to be a risk.

Amazon climbs into low-income consumer market

Amazon is currently a market disruptor in a variety of industries, and this one is no

exception. It is possible that they will be able to steal market share in this space by offering discount

items online. This is exasperated by the fact that Amazon is offering a discount prime membership

to low-income earning families. However, many analysts do not see Amazon as a major threat. One

reason for this is that most Dollar General customers do not have access to a personal computer or

smart phone, and therefore could not use Amazon. Also, most Dollar General stores are within 3 to

5 miles from customers’ homes, which provides a convenience factor. Dollar General is commonly

used by low-income, rural families who need to purchase an item right away and cannot wait for

shipping. This is seen by their average ticket, which is $11, according to Value Investors Club.

Because of this, Dollar General is more immune to the threat of Amazon than large-box retailers

like Target and Walmart. - C.D.

Price Objective & Valuation Methodology

According to the comparable companies valuation model above, Dollar General is undervalued

compared to Dollar Tree (DLTR), Five Below (FIVE), and Big Lots (BIG) on multiple valuation

metrics. DG is currently most undervalued on a EV/EBIT, P/S, EV/EBITDA, and P/E basis,

respectively. If Dollar General was to stabilize at the industry average today, each of these metrics

would allow them to return at least 25% . Two metrics, P/CF and P/FCF, indicate that Dollar

General is undervalued by 6% compared to the industry. While 6% is a positive return, this basically

means that Dollar General is pretty much fairly valued on these two metrics. All in all, this valuation

methodology shows that Dollar General is undervalued compared to their industry. - WA

Conclusion

Overall, our team is recommending a buy on Dollar General. We believe it to be

undervalued relative to its peers as well as the market as a whole. We believe that the capital

allocation strategy, store growth, and competitive position provide them with the opportunity to

gain market share and appreciate value to shareholders. We have strong conviction in the recession

proof industry and we think Dollar General is poised to outperform competitors for years to come.

As a result of our valuation analysis, we see an average implied ROI of 27.4% - Team

Citations

● Bloomberg Terminal

● Morningstar

● SEC.gov

● Ibisworld

● Dollar General Investor Relations

● Dollar General Annual Reports