Dollar General: Paying the Price for Thumb Sucking
Dollar General (DG) recently reported financial results for the second quarter of fiscal 2019. It was another strong print for the retailer, with same store sales (comps) increasing 4% due to a combination of traffic and ticket growth. And it was another period of outperformance relative to competitor Dollar Tree (DLTR), which reported a 2.4% increase in comps in the quarter.
Looking at the two-year stacked comp, which smooths out the noise of one-time events in any given quarter (like weather or the timing of SNAP benefits), we can see that Dollar General has reported a pretty consistent improvement in their results over the past three years:
As shown above, the two-year stack was +7.7% -- their best result in nearly six years.
The store count now stands at nearly 16,000 units, an increase of 5.5% over the past year. For the year, management plans to open nearly 1,000 new stores, in addition to 1,000 remodels (as noted on the call, remodels with coolers generally deliver a 10-15% lift in unit sales). The combination of comp growth and new units has resulted in consistent revenue growth over the past five to 10 years:
In addition to revenue growth, the retailer has done a good job managing expenses. Gross margins in the quarter expanded slightly despite a headwind from continued mix shift towards lower margin consumables (this is the leading category to date, with revenues up 9%). In addition, despite strategic investments like DG Fresh and NCI, they've leveraged operating expenses (adjusted for the impact of a legal matter), with SG&A as a percentage of sales falling ten basis points.
As a result, adjusted operating income increased by 12% to $1.1 billion. The company continues to return capital to shareholders (roughly 50% of cash flow from operations in the first half of fiscal 2019), with the diluted share count falling by 3% year-over-year to 259 million shares. Adjusted earnings per share has increased at a double digit rate year to date.
Management updated guidance for the year, which calls for a roughly 3% comp, a high-single digit increase in revenues, and a roughly 10% increase in earnings per share. As shown below, this result would be a continuation of impressive long-term growth from Dollar General:
Against 2019e earnings per share of approximately $6.6 per share, the stock now trades at nearly 24 times forward earnings. As the trend in the financial results has improved in recent quarters, the multiple has climbed higher. It's hard to argue with Mr. Market's conclusion. The business model is clearly working and management is making investments for the future. You can make a strong case that Dollar General is on pace to deliver high-single digit earnings-per-share growth for many years to come. Inclusive of the dividend and assuming no change in valuation, that's a setup for double digit annualized returns in a world where the long-term government bond yields less than 3%.
Conclusion
I made a mistake passing on Dollar General earlier this year. To be clear, I am not saying that because the stock has gone up (significantly) in the short-term. I say that because I did my due diligence, was in a position to appreciate the long-term competitive position of the business and its growth prospects, saw a stock price that seemed reasonable... and then sat around sucking my thumb. Well, all I can say for now is that I have paid the price for my inaction.
But that's the past. The question we need to answer today is whether Dollar General is a reasonable investment at current levels (the stock closed Friday at $156 per share). It probably sounds nuts to say this after a meaningful move higher for the stock, but I think a long-term investor could still make a case for Dollar General here. Said differently, if you held your noise and bought the stock despite its 45% climb year to date, I bet you might look back in ten years and be happy with the result. The fact that I'm not doing so (yet) probably speaks more to the behavioral cost of having "missed" this investment than it does to the underlying attractiveness of the security.
Disclosure: None.
This article first appeared on GuruFocus.
