Dollar General Corp. (DG, Financial) serves a vital need in the American economy and has been recently reporting some pretty bad news, which could be indicative of a broad decline across the market that is coming soon. When I first started to look over the company, I wanted to like it and write something more in line with the stock being undervalued. That is mostly because on the surface, it looks that way. When you dig into the numbers, it is quite the opposite.
General history
The company began in 1939 as a family-owned business called J.L. Turner and Son in Scottsville, Kentucky, owned by James Luther Turner and Cal Turner. In 1955, the name changed to Dollar General Corp., and in 1968 it went public. Fast forward to 1990 and it was in the Fortune 500. By 2020, it had reached the 112th position on that list. Today the company generates nearly $39 billion in revenue and $2.1 billion in net profit. More importantly, Dollar General has grown to become one of the most valuable stores in the rural United States, with 80% of its stores near towns with fewer than 20,000 citizen.
The brand
Dollar General delivers convenience, quality brands and low prices. The company's stores aim to make shopping a hassle-free experience with small, neighborhood stores selling carefully-curated merchandise assortments to simplify shopping.
While nearly 75% of the U.S. population within five miles of a Dollar General, the company strategically positions its stores in less densely populated areas where large retailers are unable to thrive. With the majority of its items priced at or below $5, the company offers a shield against online rivals. This approach ensures it caters to its primary customer base, households earning around $40,000 annually. Also, these used to be DOLLAR stores, now they are $5 stores. Thus, Dollar General has successfully (so far) been able to raise prices to meet inflation.
The company's sales predominantly come from consumable goods, accounting for roughly 80% of revenue. Other product categories mainly enhance profit margins and the average transaction value. By expanding its health and beauty range, Dollar General is trying to make its stores a one-stop shop for essentials.
Going digital
Finally embracing the digital age, Dollar General has launched a mobile app featuring digital coupons, which offer savings and gathers crucial data on shopping trends, tastes and patterns. The introduction of self-checkout in certain stores enhances the customer convenience and will reduce staffing costs long term, especially with a rising minimum wage and inflation.
Dollar General estimates that 70% of its core shoppers have a smartphone, which is why the compnay is rolling out self-checkout to help reduce labor needs, further enhancing its cost position and boosting in-store electronic surveillance measures to mitigate theft. Dollar General's lower-cost items serve as protection against digital competition with shipping costs on the rise. The average shopper is spending roughly $12 on five items, yet only time will tell if these meaures will impact its cost structure.
The competition
That said, customer loyalty is far from guaranteed, but switching to other retailers is not effortless considering the time and expense it takes to purposefully pass a Dollar General store on the way to a compeititor. The company competes with a range of retailers, from convenience stores and supermarkets to online giants like Amazon (AMZN, Financial). It also has to contend with regional discount chains like Fred's, 99 Cents Only Stores, Dollar Tree (DLTR, Financial), Five Below (FIVE, Financial) and Ollie's Bargain Outlet (OLLI, Financial), who target the same customers.
Dollar General has established itself as a go-to retailer in rural areas and small towns that bigger box stores do not serve. It tailors merchandising to these communities. The comapny has over 20 dedicated distribution centers and a private trucking fleet to control costs. This allows it to offer low prices. It also has strong private label brands that build customer loyalty, such as Clover Valley food and home essentials.
Expansive network
Of course, the company's biggest competitive advantage is the store count. As of Jan.1 , Dollar General operated 18,774 stores in the continental U.S. and Mexico. While digital alternatives are diminishing the value of the company's localized network of stores, the proximity is still especially valuable to low-income customers that value convenience and price. Furthermore, the retailer has successfully brought choice and more products to rural areas with limited alternatives. Moreoer, the company's stores range from 3,500 square feet in urban areas to around 16,000 square feet in more isolated rural regions. Target (TGT, Financial) and Walmart (WMT, Financial) have average store sizes from 135,000 to 182,000 square feet, respectively.
The company is known for focusing on a lower-income shopper and private-label offerings, but Dollar General is also a valued partner for branded manufacturers. While larger pack sizes found at big-box grocers give customers better unit economics, lower-end customers have significantly less financial flexibility to commit limited capital to a value size package. This means Dollar General meets customer needs for a low absolute dollar price point through smaller packages that can carry better margins for both the retailer and manufacturer. This is why you see Dollar General's gross margins in the 30% range, while Walmart and Target's are in the mid-20s.
Thoughts on valuation
Value to the consumer does not always mean the price you pay is worth it. Currently, Dollar General is priced at $24 billion with another $18 billion in total debt ($7 billion of which is long-term debt) and only $338 million in cash. The company does generate over $1.7 billion in cash from operations, but it has not been able to translate that into growth in retained earnings or book value, which is disappointing.
All told, catering to the demographic it does may serve more of a hinderance to growth. Is Dollar General needed by society? Absolutely. Does that make it worth owning at this price? No.
The stock is down nearly 5% today, likely leading some to consider it a fat pitch. Sales and income are up over the last five and 10 years, so it is easy to see why, considering the company trades at 67% of revenue. It just seems like an easily copied and recreated model, one where there is no real branding advantage. If Dollar General went belly up tomorrow, another company would replace it almost immediately. That is why it still seems overvalued.
