Discount department stores offer a wide range of different products. The total U.S. market size for the industry is forecast to be about $99 billion this year. While the secular, long-term growth trends for the industry have been weak for many years, today’s macroeconomic conditions offer many opportunities for growth. Dollar General (DG) is a discount retailer that is set to benefit in the current market environment. I am bullish on the stock.
With the economy closer to a recession, traditional retail spending is expected to deflate, and discount retail is well-positioned to gain momentum. As inflationary pressures mount, consumers turn to discount stores to combat the drop in purchasing power they are experiencing.
Dollar General operates over 18,000 stores in 47 states. The company offers a wide selection of merchandise, including home products, clothing apparel, electronics, and more.
Due to its defensive nature, Dollar General has performed relatively well this year. DG stock has gained 4.7% year-to-date, currently trading at around $247 ($56 billion market cap), relatively close to 52-week high levels of ~$262.
DG Has Seen Solid Growth That is Expected to Continue
Over the last decade, despite operating in an industry that has historically lacked growth, Dollar General has shown a solid financial performance. Revenue has grown at 10, five, and three-year CAGRs of 8.5%, 9.1%, and 9.7%, respectively, with net income recording even larger annual increases between 10% and 13%. Based on its track record alone, one can expect continued growth.
For the 2021 Fiscal Year, Dollar General generated $34.2 billion in sales compared to $16 billion 10 years ago while earning $2.4 billion in profits after tax compared to $0.95 billion 10 years ago.
Dollar General’s profitability capacity, while not impressive, remains sufficient, with a gross margin of 31.2% (vs. ~37% sector median) and a net margin of 6.6% (vs. 5.8% sector average). Return on invested capital and return on assets come in at 11.8% and 8.7%, respectively.
In terms of generating cash from its operating activities, DG has been consistently reliable. Cash provided from operations has grown steadily over the past decade, from $1.1 billion in 2013 to $2.9 billion in 2022, even surpassing net income productivity.
Capital expenditures continue to increase as the company reinvests in order to drive sales growth. Over the past fiscal year, Dollar General allocated $1.07 billion to capital expenditures.
Over the next few years, consensus among analysts looks for the company’s growth trajectory to continue. Revenue is expected to continue growing by mid-single digits for the next three to four years, while net income growth is projected to be between 10% and 15%.
At these levels of growth, Dollar General should have ample room to escalate its dividend growth and buyback campaign, further increasing shareholder value.
DG’s Balance Sheet Isn’t Concerning, but It Could Improve
The increasing pile of debt reflected on DG’s balance sheet is hardly an area of possible weakness for the business, given the relatively small size of the debt balance compared to the company’s capitalization.
The company’s long-term debt balance increased from ~$2.8 billion in 2013 to almost $4.2 billion in 2020. That said, increasing interest expenses could have a negative impact on net profits.
When it comes to liquidity, its current ratio of 0.97 is not ideal. It indicates that some inventory and receivable management improvements should be made, going forward. The current ratio is calculated as current assets divided by current liabilities.
Above-Average Dividend Growth, Consistent Share Buybacks
While reinvesting excess cash flow back into the business to sustain the company’s growth trajectory remains a top priority for management, dividends and buybacks are both parts of the company’s long-term strategy as well.
Even though DG’s current forward dividend yield of 0.9% is relatively small compared to market and sector averages, its growth outlook is not. Over the past five years, dividends have grown at a 14% CAGR, surpassing the sector’s annualized growth of around 5.5%. Three-year growth is even higher, at a 17% CAGR, compared to the sector’s 4.8%. DG also maintains a low payout ratio of 20%.
In terms of share repurchases, the company has affirmed its commitment to increasing shareholder value by reducing the share count. Since 2013, basic average shares outstanding have decreased from 332 million to 234 million (an overall 30% decrease).
During the first quarter of 2022, Dollar General repurchased 3.4 million shares, while for 2022, management looks for another $2.75 billion in share buybacks.
All these attributes can establish DG as a viable, long-term dividend growth choice, especially for younger investors with a longer time horizon ahead.
DG’s Fundamentals Justify Its Valuation
Valuation is an area where things become a bit more confusing for investors. Having resisted the pullback the broader market is facing, the firm’s valuation has remained at relatively high levels compared to peers.
Forward P/E and P/S multiples of 21.4x and 1.5x initially appear somewhat expensive, given the status of the market. However, considering Dollar General’s growth performance in a sector known for stagnating sales and the benefits a defensive stock offers during an economic downturn, today’s multiples look more justifiable. The stock also trades at a 16.4x forward P/CF multiple and at 1.9x forward EV/Sales.
Wall Street’s Take on Dollar General Stock
Turning to Wall Street, Dollar General has a Strong Buy rating based on 12 Buys, two Holds, and zero Sell ratings assigned over the past three months.
The average Dollar General price forecast of $260.75 represents 5.6% upside potential, with a high price forecast of $287 and a low forecast of $227.
Conclusion: DG is Attractive Despite Its Elevated Valuation
After all things are considered, Dollar General presents an attractive investment choice, especially during the current macroeconomic environment.
Strong financial performance and consistency in increasing shareholder value are only hampered by a somewhat elevated valuation for an otherwise promising stock.
