Dollar General: Value or Value Trap?
I spent Labor Day weekend reading about this beaten down retailer. This article provides some initial thoughts on the company.
I often engage in “rubbernecking” when I come upon the scene of a debacle causing a company’s stock price to plummet. Last week, Dollar General’s precipitous decline following its earnings release caught my attention. After falling 12.2% on Thursday, August 31, the stock declined an additional 5.9% on Friday, September 1. The stock, which closed at $130.27 on Friday, has been cut roughly in half since October 2022. The company’s market capitalization is $28.6 billion.
Dollar General is not a company that I have followed in the past. However, a quick look at the annual report led me to believe that I am capable of understanding the business. I noted that the company posted earnings per share in excess of $10 in each of the past three years and has an attractive long-term growth story. My interest increased when I looked at dataroma.com to see who owns the stock. I’m against blind coat tailing, but when investors I highly respect not only own the stock but were adding to their positions recently at much higher prices, I can’t help but take notice!
After spending an hour on the situation, it was obvious why the market punished the stock. The business has performed very poorly this year and management has cut its guidance for the rest of the year. If you’re trying to beat the S&P 500 this year, who wants to be in a company that’s likely to post ugly results three months from now? However, what if the company can get back on track? Management continues to open new stores and, if past profitability and unit economics can be restored, perhaps this is a company that could earn $15 per share in five years and again trade at twenty times earnings. That scenario could produce an annual compound return of ~18%.
I caution the reader that I am not making predictions that this rosy scenario will happen and my background with the business is literally just three days old. This article is not a comprehensive business profile comparable to the series I wrote last year which was discontinued in January. Each of those profiles was the product of several weeks of work. However, I thought that the information I have gathered so far on Dollar General might be useful for readers who are not yet familiar with the company and interested in a starting point for their own research.
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The retail landscape in the United States is intensely competitive. Consumers are aware of the importance of seeking the best value for their money in all economic environments but this need becomes acute during economic downturns and times of high inflation. There are no one-size-fits-all retail strategies in a vast country of 330 million consumers with a diverse mix of urban, suburban, and rural communities that have unique needs and face very different economic pressures.
I spent a couple of years living in a rural community more than twenty years ago. At that time, the only local retail option was a convenience store next to a small restaurant and gas station. Those of us who commuted to the nearest city had access to all of the typical retail options on a daily basis, but people who worked locally would not necessarily want to drive long distances more than once a week. The local “mom and pop” store served their needs for purchases during the week.
Dollar General specializes in serving the needs of small towns and rural communities with over 80% of its 19,488 stores located near towns of 20,000 or fewer people. The company operates more stores than any other retailer in the United States and has locations within five miles of 75% of the U.S. population. Dollar General stores are typically bare-bones small-box formats which average 7,500 square feet. A typical grocery store has about four to five times as much space while the average size of a Wal-Mart Supercenter is a whopping 178,000 square feet.
With its extensive store footprint, Dollar General benefits from economies of scale that allow for vertical integration. The company operates nineteen distribution centers for non-refrigerated products, ten cold storage distribution centers, and two distribution centers for both refrigerated products and general merchandise. The company more than doubled the size of its private tractor fleet in 2022 and anticipates having more than 2,000 tractors by the end of 2023. The distribution centers and transportation fleet provide significant control of the supply chain.
The following exhibit from Dollar General’s 2022 annual report shows the locations of the 19,104 stores in 47 states that it operated as of February 3, 2023 along with the location of its distribution centers. In addition to the Dollar General brand, the company operated 190 pOpshelf locations selling non-consumable products.
The store base is geographically concentrated in the south, southeastern, and midwestern United States and management has been adding locations rapidly over the past decade. The exhibit below shows the growth in store count since 2014:
Even during a challenging year, store growth has not stopped and it appears that there is room for many more store openings in the years to come. To understand why Dollar General has an opportunity to make headway in more rural locations, I recommend a Wall Street Journal article published in 2017 that describes the customer base.
Of course, the devil is in the details, so let’s take a closer look at some key metrics over the past decade with a focus on how the company has hit turbulence this year and whether management is likely to get back on track.