2024-01-09 06:27:24 ET
Summary
- Dollar General Corporation shares have declined significantly in 2023, but are still up over 550% since 2009.
- The company has faced challenges including a weak consumer market, labor issues, and scrutiny over low wages.
- Despite these challenges, DG aims to rebound through strategic initiatives such as focusing on private brands, inventory management, and expanding in rural areas.
Introduction
2023 was a tough year for the Dollar General Corporation ( DG ) - a very tough year.
At the end of 2022, DG shares were changing hands at prices close to $260. While I am writing this, sellers are willing to part ways with their shares for less than $140.
What's interesting is that despite this implosion, DG shares are still up more than 550% since 2009, beating the S&P 500 by almost 100 points!
Despite the stock price decline, DG shares have returned 14.2% per year since 2009, which is truly a breathtaking number, given that we're dealing with a low-cost retailer, not a fancy company from Silicon Valley.
My most recent article on the company was written on June 1, 2023, when I went with the straightforward title "Dollar General Imploded."
Here's a part of my takeaway (emphasis added):
Dollar General, the largest discount store in the nation, experienced its worst day ever as investors worried about a weakening consumer market . The company reported decent numbers but issued poor guidance, attributing the challenges to poor consumer sentiment and shrinkage issues.
The economic environment remains challenging , with lower-income shoppers cutting back on discretionary purchases . Consumer sentiment indicators and access to credit reflect the tough conditions.
[...] Given the current economic climate, it's advisable to hold off on investing in Dollar General and similar consumer stocks - at least for the time being.
Since then, DG shares have fallen another 15.5%, including dividends, underperforming the 10.8% return of the S&P 500 by a wide margin.
Hence, in this article, I'll take a look at efforts to trigger a rebound, the economic environment, its risk/reward, and what it takes to go back to 14% annual returns.
So, let's get to it!
Dollar General Is In A Tough Spot
Generally speaking, I like budget stores. They often offer great value, especially in times of elevated inflation.
Hence, last year, even higher-income people started to visit dollar stores more often.
Unfortunately, the consumer was so weak that the company saw tremendous pressure on its sales.
On top of that, it started to encounter labor issues, which were somewhat related to the tough economic environment.
With that in mind, on September 20, 2023, Bloomberg ran the following headline :
Although it's a few months old, it's still relevant, as Bloomberg noted that with most employees earning less than $12 per hour, Dollar General faces criticism for its low wages.
The hazardous conditions, including blocked exits, unaddressed maintenance issues, and aggressive customers, contribute to a challenging work environment.
With that said, I get these problems. When we look at the chart below, we see that both Dollar General and its peer Dollar Tree ( DLTR ) have seen significant increases in OSHA fines since 2021.
2021 marked the start of the acceleration in inflation. Also, back then, supply chain issues were horrible, adding massive pressure to the profitability of companies that buy a lot of products overseas.
Furthermore, people started to demand higher wages, which is an issue for companies trying to keep prices low.
This is what Dollar General wrote in its 2022 10-K :
Our ability to pass along labor and other related costs to our customers is constrained by our everyday low price model , and we may not be able to offset such increased costs elsewhere in our business.
While high inflation tends to increase the total addressable market of dollar stores (budget-conscious shoppers), it poses a tremendous risk for the core of its business: keeping prices low.
It's also a risk for its massive business expansion. Last year, the company came close to 20,000 stores. It had 9,000 stores during the Great Financial Crisis!
A physical store expansion is tough in an environment of elevated rates, pressure on the consumer, and other issues related to physical stores, including theft and unhappy employees.
I have seen way too many videos of stores being looted, employees quitting, and related store closures.
Things have gotten so bad that I started limiting my exposure to physical stores. The only direct cyclical consumer exposure I have is through Home Depot ( HD ).
That said, it's not all gloom and doom.
I still have faith in Dollar General, especially if we eventually enter a situation of lower inflation, which should help the company improve its margins and benefit from its larger addressable market.
Between Headwinds And Business Improvements
Last month, Dollar General reported the third-quarter earnings of its 2023 fiscal year.
To start with some bad news, gross profit as a percentage of sales declined by 147 basis points to 29%, primarily attributed to increased shrink (people stole more goods), lower inventory markups, and heightened markdowns.
Simultaneously, SG&A as a percentage of sales rose by 183 basis points to 24.5%, driven by factors such as retail labor costs, targeted labor investment, depreciation, amortization, repairs, maintenance, rent, professional fees, and other services purchased.
Furthermore, the company reported a 2.4% increase in net sales, reaching $9.7 billion compared to $9.5 billion in the same period the previous year.
This growth was driven by an expansion in market share in both consumable and non-consumable product sales.
However, same-store sales experienced a decline of 1.3%, primarily attributed to a reduction in the average transaction amount.
Unfortunately, as a result of cost headwinds, the operating profit for the third quarter saw a substantial decline of 41.1% to $433.5 million.
Unsurprisingly, this decline was mirrored in the operating profit margin, which decreased by 330 basis points to 4.5%.
Adding some context to its sales, the decrease in same-store sales was consistent across all four product categories, reflecting a challenging retail environment.
During the earnings call, the company acknowledged the impact of customer spending constraints, supported by survey data indicating significant pressure on customer budgets.
The expectation is that customer spending may continue to be constrained in discretionary categories in 2024.
As we can see in the chart below, low-income consumer expectations are at levels similar to the Great Financial Crisis, so the company's expectations are no surprise.
The good news is that in terms of the supply chain, the company acknowledged progress in overcoming distribution capacity constraints but identified additional opportunities for improvement.
The goal is to achieve on-time and in-full ("OTIF") deliveries, simplifying work for store teams and enhancing the overall customer experience.
Unfortunately, shipping costs are rising again due to the Houthi attacks on container ships. Although this is expected to be a short-term issue, it is likely to lead to higher costs, which I expect the company to mention in its next earnings call.
Drewry.co.uk
Going back to improvements, during its 3Q23 earnings call, the company also discussed merchandising strategies, with an emphasis on offering great value to customers in a challenging economic environment.
The company plans to highlight private brands, explore opportunities for savings, and maximize the effectiveness of promotional activities.
SKU rationalization is a key component of the merchandising strategy to reduce inventory and improve operational efficiency.
In other words, it wants to offer fewer products and focus on products with better value that allow it to better manage inventory levels.
Thanks to these efforts, the company sees significant growth opportunities and remains committed to its real estate expansion plans. In fiscal 2024, it aims to execute approximately 2,385 projects, including new store openings, remodels, and relocations.
The focus is particularly on rural stores and larger store formats, which is a hot trend in the industry, as nobody feels really comfortable expanding in major cities (due to crime and related issues).
Where's The Shareholder Value?
Looking ahead, the company expects net sales growth to be in the range of 1.5% to 2.5% for the fiscal year 2023, while same-store sales are expected to decline by approximately negative 1% to remain flat.
The EPS outlook is in the range of $7.10 to $7.60, representing a decline of negative 34% to negative 29%.
In light of these numbers, the company used its earnings call to emphasize a disciplined approach to capital allocation with a clear hierarchy of priorities.
- The first priority is investing in the business, which includes investments in existing stores as well as high-return organic growth opportunities such as new store expansion and strategic initiatives.
- The second priority is returning cash to shareholders through quarterly dividend payments.
The company currently pays $0.59 per share per quarter. This translates to a dividend yield of 1.7%, which is 30 basis points above the 1.4% yield of the S&P 500.
This dividend is protected by a sub-30% payout ratio and comes with a five-year dividend CAGR of 15.5%, which is impressive and skewed by a 31% dividend hike on May 17, 2022.
However, in this environment, it is likely that dividend growth remains subdued, as the company not only struggles with economic headwinds but also has a slightly elevated leverage ratio.
Although our leverage ratio is currently above our target of approximately 3x adjusted debt to adjusted EBITDAR, we are focused on improving our debt metrics in order to support our commitment to our current investment grade credit ratings, which, as a reminder, are BBB and BAA2. With all of that said, cash generation is very important, particularly in this environment, and we are focused on maintaining and improving strong cash flow as we head into 2024. - DG 3Q23 Earnings Call
Nonetheless, the company has a healthy credit rating and a 2.0x 2024E net leverage ratio, which is very decent as well.
The same goes for its valuation, which I also would call "very decent."
Using the data in the chart below:
- Dollar General is currently trading at a blended P/E ratio of 17.7x.
- Its normalized valuation since its IPO in 2009 is 18.9x.
- In the current fiscal year, EPS is expected to decline by 30%, which is in the middle of the aforementioned guidance range.
- In the 2024 fiscal year, EPS is expected to remain flat, followed by an expected improvement of 13% in 2025.
- Based on these numbers, it seems analysts are expecting a gradual recovery, which is a scenario that is very likely.
- When combining the normalized multiple of 18.9x with expected EPS growth, we get an expected annual return of 9.7% through 2026, which makes sense if consumer sentiment is able to improve in the quarters ahead.
In order to return more than 14% per year, like it did in the past, the company needs more than a successful strategy to grow its margins.
Unless economic growth rebounds with support from much stronger consumer sentiment and inflation rates close to 2%, I expect DG to return 8-10% per year at best, which wouldn't be the end of the world.
So, despite my view that inflation will remain sticky on a prolonged basis and my distrust of the physical store model in these times, I'm giving the stock a Buy rating, as the valuation is too attractive to remain neutral.
Takeaway
In 2023, Dollar General faced significant challenges, witnessing a steep drop in its stock value despite a history of remarkable growth.
The company grappled with a weak consumer market, labor issues, and scrutiny over low wages.
While economic headwinds persist, Dollar General aims to rebound through strategic initiatives, focusing on private brands, inventory management, and real estate expansion in rural areas.
Despite a decline in sales and earnings, the company prioritizes shareholder value, maintaining a disciplined approach to capital allocation and sustaining a competitive dividend.
With a compelling valuation, Dollar General presents a buying opportunity, banking on potential recovery and improved consumer sentiment.
For further details see:
The Bull Case For Dollar General To Return >9% Per Year