Dollar General (DG, Financial) recently reported financial results for the second quarter of fiscal 2020.
It was another stellar quarter for the retailer, with same store sales (comps) increasing 19% and significant growth in ticket offset by a low-single digit decline in traffic as customers consolidated their trips to the store.
Strength was broad-based, with sales in every category growing by 20% or more in the quarter. Notably, it was another period of meaningful outperformance relative to competitor Dollar Tree (DLTR, Financial), which reported a 7% increase in consolidated comps and a 12% increase at Family Dollar, which is Dollar General's closest peer. Looking at the two-year stacked comps, we can see that Dollar General has seen a significant tailwind in the first half of 2020 from the pandemic, following an already impressive trend of better results over the past few years:
In addition, as noted in the press release, the strong results have largely continued, with same store sales up mid-teens in August (note that Dollar Tree management recently told investors that comps at Family Dollar have increased high-single digits in August).
At the end of July, Dollar General had 16,720 stores across the United States, an increase of 6% over the past year. In 2020, management plans to open roughly 1,000 stores in addition to nearly 1,700 remodels (including the installation of more than 30,000 cooler doors).
Importantly, as noted on the call, management still believes that there are many years of unit growth ahead, with the opportunity to add more than 10,000 additional Dollar General units in the United States. The combination of same-store sales growth and new units has resulted in 26% revenue growth in the first half of the year, on top of consistent high-single digit growth at Dollar General over the past five to 10 years.
In addition to revenue growth, the retailer has done a good job managing costs. Gross margins in the first half of 2020 were 31.6%, up more than 100 basis points from the year ago period. This expansion reflects mix shift towards non-consumable product categories, which generally have higher gross margins, as well as a reduction in markdowns. In addition to higher gross margins, and despite strategic investments and incremental costs associated with operating during the pandemic, they also leveraged operating expenses, with SG&A as a percentage of sales falling by roughly 200 basis points through the first six months of the year. Due to the combination of double digit sales growth and meaningful margin expansion, adjusted operating income increased 70% in the first half of the year to $1.9 billion.
After temporarily suspending the program to preserve liquidity, the company restarted share repurchases in recent months, buying back more than $600 million of stock in the second quarter at an average price of $188 per share. As a result, the diluted share count declined by 3% year-over-year to 252 million shares.
Measured against a normalized 2020 earnings per share (EPS) estimate of $7.60 to $7.90 per share, which assumes a mid-teens growth rate compared to the $6.60 per share reported in 2019, Dollar General now trades at roughly 26 times normalized earnings. As the trend in the company's financial results has improved in recent years, the valuation has climbed higher. For example, the price-sales ratio is currently about 50% above where it has been, on average, over the past decade.
Personally, I find it difficult to argue with Mr. Market's conclusion. While the environment has been favorable for the company in recent months, I think the results in the past few years have shown the business model is clearly working. In addition, management is making investments for the future (new stores and as other investments to improve the unit economics of the base) while returning capital to shareholders. I continue to believe Dollar General is on pace to deliver double digit EPS growth for many years to come. Inclusive of the dividend, and even assuming the forward multiple contracts to 20 times over the next five to 10 years, that's a setup for 10% annualized returns or higher in a world where long-term government bonds yield 1% - 2%.
Conclusion
In hindsight, missing the chance to buy Dollar General back in March at less than $140 per share was a mistake (of course, that's true for most big stocks if you simply compare today's price to where the stock traded in March). At that price, the company was trading at less than 20 times my estimate of normalized earnings – in my opinion, too cheap for a high-quality business like this one. Mr. Market has corrected his error, with the stock up more than 50% from the lows.
A year ago, when the stock traded around $150 per share, I wrote the following:
"The question we need to answer today is whether Dollar General is a reasonable investment at current levels. 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 DG here. Said differently, if you plugged 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."
Today, with the stock trading 35% higher, I think that hurdle has risen slightly. But with that said, I still think the conclusion largely holds at these levels. If you bought Dollar General today and held it for the next decade, I bet you would probably receive an acceptable outcome. Why I've stayed on the sidelines, and continue to do so today, is a valid question.
Disclosure: None
Read more here:
- Dollar Tree: Continued Strength at Family Dollar
- Ollie's: 'Our Best Quarterly Results in Our 38-Year History'
- Does 'Don't Lose Money' Hurt Berkshire Shareholders?
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