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Dollar General Cruises Past Expectations

GuruFocus.com
·8 mins read

- By Nathan Parsh

Dollar General Corporation (NYSE:DG) has been an excellent investment to own this year. The stock has easily outpaced the S&P 500 so far in 2020, returning more than 25% while the market index is higher by just 7%. The discount retailer is up nearly 45% since the March lows.

I've already covered other retailers that had strong quarters, like Target Corporation (NYSE:TGT) and Lowe's Companies (NYSE:LOW), and I feel that Dollar General also turned yet another excellent quarter.


Despite this, shares of Dollar General are only somewhat more expensive then they have been on average over the last five years. Let's dive deeper into the company's most recent quarter to see why investors looking for exposure to the retail space might consider buying Dollar General.

Quarterly highlights

Dollar General released its second quarter earnings results for fiscal 2021 on Aug. 27 (the company's fiscal year ends Jan. 30). The analyst community had anticipated much improved results on both the top and bottom-line compared to the second quarter of the previous year, but the company managed to exceed even these expectations. Revenue grew more than 24% to $8.7 billion, which was $335 million ahead of estimates. Earnings per share increased $1.47, or 89%, to $3.12, which was 68 cents better than expected.

Growth was found nearly everywhere during the quarter. Same-store sales growth was 18.8%, which was better than consensus estimates of 14.9%. Sales for May, June and July improved 21.5%, 17.9% and 17.2%, respectively.

Results were positively impacted by the pandemic. Though customer traffic dipped, this was more than offset by a larger average basket cost. Consumers likely condensed multiple trips into one trip to limit the amount of social contact.

All product categories enjoyed high double-digit sales growth. Consumables, the company's largest contributor to sales, grew 19.7% to $6.5 billion as consumers ate at home more often. Seasonal products were up 36% to $1.2 billion, which was led gains in toys. Home products improved more than 56% to $586 million. Higher consumer spending on this category was likely due in part to stimulus checks and the desire to upgrade the home. Sales for Apparel products increased 35.6% to $440 million.

Same-store sales as of Aug. 25 were up 15%, a bit of a decline from the second quarter but still an impressive growth rate.

Results in the second quarter were a slight deceleration from the first quarter, where overall revenues improved almost 28% and same-store sales climbed 21.7%. However, gross and operating margins were better in the most recent quarter.

Margins results topped what analysts were looking for. Gross margins improved 167 basis points to 32.5% compared to 30.8% expected. Operating margins were higher by more than 200 basis points to 12% of sales versus 9.9% consensus estimates. Dollar General delivered margin gains due to higher initial markups on inventory and the company needed fewer markdowns to move products. Dollar General also benefited from more sales from the non-consumable product categories, which usually have higher margins.

There were some headwinds to margins as higher distribution and transportation costs resulted from increased demand, though I would argue that this isn't a terrible problem to have. The company also had higher costs related to the pandemic, particularly due to employee bonuses. Still, expenses as a percentage of revenue actually declined 205 basis points to 20.4% as higher costs were more than offset by higher sales. Dollar General was quite successful at working off merchandise, as inventory levels were down 5.9% to $4.4 billion.

The company's balance sheet remains in a very solid state. Cash flow from operations was up 157% to $2.9 billion. Dollar General ended the quarter with $3 billion in cash and cash equivalents and an additional $1.1 billion on its undrawn revolving credit facility. The company also has no current debt due within the next year and $4.1 billion of long-term debt.

Unlike so many companies that have suspended share repurchases, Dollar General repurchased 3.2 million shares during the quarter at an average price of $188. The company has $2.5 billion, or 5.1% of the current market capitalization, remaining on the repurchase authorization.

Analysts expect that Dollar General will earn $10.20 per share is fiscal 2021 according to Yahoo finance, which would be a 54% increase from the previous year. Much of this gain is due to strong results from the last two quarters, but this isn't just due to higher basket sizes as consumers stocked up on goods. Analysts believe that the company will earn $9.74 next fiscal year as well, showing that consumers are expected to remain loyal even as the business environment could be much closer to normal.

Dollar General itself hasn't issued guidance for fiscal 2021, but I believe that the company has the potential for future gains. This belief isn't only due to the results of the last two quarters, but because of Dollar General's prospects for growth.

Growth prospects

Dollar General benefits from access to many potential customers. The company has almost 17,000 locations and more than 75% of the U.S. population lives within five miles of a store. Access to stores is not that much of an issue, even for low income consumers.

Unlike many retailers that are closing locations to try to survive, Dollar General is making aggressive investments in its stores. The company spent $424 million in the first half of the year and plans to reinvest at least $1 billion for the year in remodeling and opening new stores. Plans for expansion continue to move forward, with the company expecting to open 1,000 new stores, remodel almost 1,700 current stores and relocate another 110 locations this year alone.

Dollar General is well on its way to meeting these goals, as the company has already opened 500 new locations, remodeled almost 1,000 stores and relocated 43 stores in the first half of the year.

The company's remodeling efforts include an increase in the number of cooler sections in each store, something leadership has said has worked to drive sales growth at other locations. Dollar General added 30,000 cooler doors across its store locations in the first half and is scheduled to install a similar number over the rest of the year.

In addition, the company is taking strides to appeal to the more health conscious consumer by providing fresh produce to customers at 870 stores.

Dollar General also has a partnership with FedEx Corporation (FDX). More than 8,000 locations now offer drop off and pick up services for packages, which can provide stores with potential new customers.

Finally, Dollar General's app allows customers to buy online and pickup in stores. This app was only available at a handful of stores in the first quarter, but should be available across the whole portfolio by the end of the year. The company stated on the conference call that the data says that the typical shopper usually buys additional products when making their pickup.

In total, Dollar General has a lot of irons in the fire that should help propel growth in future years even after the high sales related to Covid-19 have normalized.

Final thoughts

Dollar General easily topped already heightened expectations for the second quarter as each of the company's product categories experienced incredible demand. While fewer consumers visited stores, they bought a lot more items.

Helping to drive this demand were growth initiatives like increased refrigerator space, digital shopping and new and remodeled stores.

Based on Friday's closing share price of ~$196 and analyst EPS predictions for the year, Dollar General trades with a forward price-earnings ratio of 19.2. This is just above the five-year average price-earnings ratio of 18.5. Despite the recent results, the stock is only slightly overvalued today.

While the pandemic added a significant amount to same-store sales growth, Dollar General has a long history of growing its business all on its own. For example, the company had 3.9% same-store sales growth last year, the 30th year in a row where comparable sales were higher. The company's discount business model, sheer number of locations and proximity to customers likely will result in many more years of growth.

For these reasons, I believe that Dollar General could be an excellent investment for those looking to own a discount retailer.

Author disclosure: the author maintains a long position in Dollar General

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This article first appeared on GuruFocus.