“We have turned the clock back. We’re actually now only in the fourth inning. We see a tremendous runway ahead of us there”
CEO Todd Vasos didn’t mince his words. I’ve never invested in Dollar General stock before (to my detriment) because I thought the growth and reinvestment story had come to a close. That was wrong.
Despite being brick-and-mortar focused, they continue to excel in basically any operating environment. Their unique real estate strategy, where they set up low-cost buildings in rural towns as the one-stop-shop at affordable prices, is key.
I’m filing this post under my competitive strategy series because clearly Dollar General is a stellar retailer with unique strategy – and the stock has delivered excess returns.
Since the beginning of 2015, I’ve watched store count grow from 11.8k to ending 2020 with over 17.1k stores. That is a 46% increase!
Dollar General stock benefitted from this growth despite being an “old school” business — no FANG here, but with FANG-like returns. Coming from brick-and-mortar retail, no less.
They don’t appear to be overloading the system either. Going back to 1993 – Dollar General hasn’t had a year when SSS comps have declined.
So if you invested in Dollar General, you’d have benefitted from
- Growing stores
- SSS Comp increases
- Margin enhancement from this operating leverage
- A high ROIC / highly cash generative model (even now, Dollar General mgmt estimates the stores are a 2-year payback)
Ok, again. I missed all of that growth. How could one possible invest in Dollar General stock now? Especially with the dawn of e-commerce, is it rational to expect the company can continue to perform?
There are still a bunch of reinvestment opportunities at very high rates of return. I will outline six different ones the company is targeting:
- DG Fresh – Increasing stock of perishable & frozen items. Self-distributing these products as well to control costs
- This really started in earnest back in 2013 as DG increased the amount of cooler doors in their stores.
- At the end of 2012, DG stated they had about 11 cooler doors per store. By the end of 2018, they had 20 doors per store. They expect to install 60k in 2020!
- Dollar General continues to view this as the #1 sales driver going forward (again driving that one-stop shop mentality).
- DG Fresh also entails distributing these items themselves to help lower production costs and improve in-stock position, enhancing their competitive positon.
- The Non-Consummable Initiative (NCI) – Selling such as home decor products, seasonal items, or party items just as some examples.
- These are higher gross margin and increase transaction amounts, which helps operating leverage on stores.
- Seasonal items that rotate also helps the “treasure hunting” aspect in retail shopping.
- New Store Formats (Popshelf). DG has about 17k locations… but that doesn’t mean it can’t use its infrastructure set in place for a new concept. Popshelf is a new store concept targeting suburban women, with products priced under $5 in the seasonal, home decor and beauty products, as well as cleaning supplies and party goods.
- This stemmed from the NCI work the company did.
- Dollar General doesn’t take any decision lightly, so I think this could be a real opportunity and the US could easily support thousands of these stores.
- As an aside, and call me crazy, but I could BIG as a DG acquisition target.
- Popshelf reminds me of Big Lots, though I guess Popshelf doesn’t seem to be targeting furniture.
- There would be immense synergies, with BIG benefitting from DG’s low cost distribution as well as scale on corporate costs.
- Big Lots is still smallish with only 1,400 stores, but still has all the public company costs, back-office costs, HR, accounting, legal, etc. All of these could be scooped under the DG umbrella. It would give DG 1,400 more stores in a concept it wants to target.
- BIG also trades at less than half the multiple DG does, so it would be highly accretive to DG.
- Smaller format stores (<6,000 sq ft) for urban areas where Dollar General doesn’t currently target
- Private label / Increased Foreign Sourcing.
- Other “Core” continuous improvement items like lowering “shrink” (i.e. theft), zero-based budgeting, etc
These are six items outside of tech-enabled strategies like Buy Online, Pickup in Store (BOPIS) or the ability to scan items on your phone to expedite check-out (both of which DG has been talking about for years).
Let’s put some math behind the go-forward opportunity
DG clearly has been a COVID beneficiary. I mentioned before that DG has had tremendous SSS growth over its history, but with expected SSS of +16% in 2020, I fully expect 2021 SSS may decline for the first time.
However, DG currently has more cash than ever on its balance sheet ($2.2BN). The next highest the company has had pre-COVID was $600MM back in 2011. It’s basically been around $200MM since then.
This tells DG has $1.6BN-$2.0BN of cash to invest. It means that they can pull forward many projects they have planned.
I estimate the unit economics for a new Dollar General branch based on what they’ve disclosed (the 2016 Investor Presentation was a big help) and what I know about other retailers. Clearly the returns are pretty good.
But what this really tells me is that each $1 that Dollar General invests is worth about $10 at maturity. This assumes no growth after year 10.
Said differently than above, $1.6BN to $2.0BN invested in the company’s growth will likely translate into >$16BN of value. The current market cap is $51BN.
Coincidentally, DG’s pre-tax ROIC on tangible capital averages >50% over time based on my numbers.
If they invest $1.6BN to $2.0BN at these kinds of returns (perhaps a big IF), that could mean a $800MM-$1.0BN uplift in operating income (estimated by assuming a 50% ROIC). For a company that did $2.3BN in operating income in 2019 – that is very meaningful!
Sure, they could also use that cash for share repurchases or dividends, but like my post on Big Lots, clearly the optionality for DG, and growth, has been enhanced.
While they do have 17k stores, their goal is 25,000 locations. So $1.6BN investments, when a new location just costs $250k to open, leads to 6,400 stores right there…
Remember, DG performed very well during the great recession due to a trade down effect as the consumer wanted to save costs. This led to them having more cash than competitors to expand and reinvest in the business.
As you can see in the chart below, this is when EPS really started to ratchet up.
DG doesn’t look optically cheap today. Currently it trades at roughly 16x 2021 EBITDA and 21x EPS. That’s what used to be called a “growth” multiple. However, they have several growth avenues and you’re backstopped by earnings that actually go up in recessions. So you have growth + stability in cash flow, which drives a premium valuation.
One thing I like to look for in a stock is a doubling of EPS over 5 years. It helps me gain comfort in the multiple I am buying in at (the multiple can be cut in half and I still wouldn’t lose money). This would be tough given where we are buying in at DG (coming off of a peak COVID earnings), but they will have so much capital to deploy with many avenues. I have EPS 70% higher from where it will end 2020 due to store growth, modest SSS growth, modest margin expansion over 2019 levels and share buybacks. Assuming shares trade at 20x FCF in 5 years, I think you can earn a 14.5% IRR.
I can’t talk about a retailer without addressing e-commerce. If you think about Dollar General’s footprint, it is immense and its generally where e-commerce is still underpenetrated (i.e. rural areas).
However, that also means DG is best positioned with their distribution capabilities to attack that market. Much like they segmented rural areas for brick-and-mortar retail, they could do the same thing in e-commerce. They are the anti-Whole Foods, if you will, which many believe Amazon acquired to enhance their platform.