2023-05-12 17:59:24 ET
Summary
- Many investors anticipated that Dollar General Corporation stock would outperform in a recessionary environment. In fact, it has not.
- Dollar General's stock performance was flat in 2022 and started to decline throughout 2023, with a YTD -12% return.
- Despite the term "dollar" in their names, dollar stores are visited more for convenience than solely low price.
Poor stock performance
Despite being considered a safe haven during times of recession, Dollar General Corporation's ( DG ) stock performance was flat in 2022 and started to decline throughout 2023, with a year-to-date return of -12%.
The company grew its revenues by 10% in 2022, primarily driven by consumable growth. However, this focus on consumables, which typically yield lower margins, resulted in increased pressure on the company's gross margins. Furthermore, Dollar General's SG&A expenses were deleveraged in 2022 due to weak customer traffic and increased investments in store operations and supply chain infrastructure.
DG' financials (DG)
Dollar Tree vs Family Dollar
Meanwhile, Dollar Tree, Inc. ( DLTR ) witnessed a 12% year-to-date increase in its stock price. This remarkable performance was driven by the impressive growth of the Dollar Tree brand. The Dollar Tree banner achieved substantial improvements in both profit margins and revenues, while the Family Dollar banner faced challenges in this regard, with a 76% decline in operating income in 2022.
By examining the revenue breakdown, investors can better comprehend the differences. Both Dollar Tree and Family Dollar encountered reduced foot traffic but higher average spending. However, Dollar Tree's success was propelled by a significant increase in average spending, whereas Family Dollar saw only a modest rise in this regard.
The difference in performance between Family Dollar and Dollar Tree can be attributed to their distinct product offerings. Family Dollar primarily sells consumable items, which make up 76% of its sales, while Dollar Tree focuses on discretionary products, accounting for 57.5% of its overall sales.
In a scenario where prices are increasing, the performance of these two store types varies. Despite the term "dollar" in their names, dollar stores are visited more for convenience than solely low prices. These stores are commonly located in rural and low-income areas, where they compete with discount retailers like Walmart Inc. ( WMT ).
In an inflationary environment, people tend to choose discount retailers for grocery shopping rather than convenience stores. Walmart, with its lower prices, becomes a more affordable option for groceries compared to dollar stores. As a result, Family Dollar, which focuses on consumable sales, faces additional pressure in this competitive landscape.
Dollar General operates more similarly to Family Dollar, with consumables accounting for approximately 80% of its sales. Its performance was comparable to Family Dollar's, and its operating income declined in 2022.
Dollar Tree's brand, on the other hand, experienced less impact since its focus on discretionary and convenience items is less influenced by Walmart's competition, as people only visit occasionally for such purchases. For example, discretionary items like gift cards are not frequently bought and are often purchased at the last minute. Thus, individuals are more willing to pay a slight premium for these discretionary items.
DG Fresh push
In 2021, Dollar General took a further step in consumables by venturing into the realm of fresh grocery with the launch of DG Fresh. However, this move exerted significant pressure on the company's margins and cash flow. Managing the fresh items proved to be challenging for Dollar General. Customers complained about the fresh food's poor quality. Reviews of the fresh category showed that products like milk had shortages and received lower scores. In addition, the management issued warnings about anticipated inventory damage. Dollar General's choice to increase its investment in consumable products inadvertently thrust it into a more challenging competition with Walmart.
Rise of delivery platform
The competitive landscape in this space has significantly transformed since the 2008 crisis, with the emergence of various convenience players such as InstaCart and DoorDash ( DASH ). Dollar Tree partnered with InstaCart, while Dollar General collaborated with DoorDash. These partnerships have enhanced the overall convenience experience for customers, but they have also weakened the company's control over consumer traffic. For example, consumers have more store choices in the delivery app and are likely to pick the one with the lowest price. In addition, the rise of delivery or e-commerce platforms inadvertently benefited other low-price retailers like Walmart. Historically, Dollar General's advantage has been its extensive store network, but the emergence of platforms appears to be eroding that advantage.
As a result, we have witnessed dollar stores (both Dollar Tree and Dollar General) making a strategic move to aggressively open more stores, aiming to reduce the distance between their locations and consumers in order to protect their competitive advantage. Despite the possibility of higher expenses and limited revenue benefits from these initiatives, the companies seem to have no choice.
Increase pressure on free cash flow
Its operating cash flow was negatively impacted by two factors. First, a decrease in net income due to lower margins on consumables. Second, there was a buildup of inventory, which we attribute to increased competition and poor consumable inventory management. The company's product offerings and consumer prices were not competitive enough compared to low-cost retailers like Walmart and ALDI.
The company's significant investment in consumables and storefront renovation puts more strain on its free cash flow. Its capital expenditure rose by almost 50% compared to 2021, resulting in a decline in free cash flow to approximately $400 million in 2022 from $2.8 billion in 2021.
Consequently, this hinders the company's ability to repurchase its stocks. The company raised $2.2 billion in debt to repurchase stocks of $2.7 billion in 2022. Its net leverage ratio went up to 4.2x as a result.
The management emphasized its commitment to prioritizing store investments and lowering the leverage ratio to 3x in 2023. Dividends and buybacks have taken a backseat to their priorities. This shift is evident in the significant decrease in buyback purchases, totaling only $500 million, a mere one-fifth of the repurchase level in 2022. Consequently, this presents an apparent risk that could adversely impact the company's stock performance.
Valuation
Its forward P/E ratios stood at 19x, which were lower than those of its competitors, primarily due to an unfavorable product mix. In addition, the company's earnings and cash flow were under pressure. The company forecasted EPS growth in the low single digits and a decline in share repurchases in 2023, making its forward PEG ratio of 2.35x not very attractive and appearing more unsustainable compared to its peers.
Many investors anticipated that Dollar General Corporation stock would outperform in a recessionary environment. However, we think that modern merchants are evolving their business models as a result of advanced consumer technologies. Dollar General's DG Fresh initiative was unsuccessful. Dollar General's strategy of expanding its store count has been replicated by Dollar Tree, which makes Dollar Tree a more attractive option for investment. One of the reasons for this is Dollar Tree's diverse product mix. Hence, we rate Dollar General Corporation stock as a hold.
For further details see:
Dollar General: Things You Should Know Beyond The Dollar Sign