Dollar General 2022

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Written by

Jordan Goulet

November 16, 2022

10 min read

Recently, I listened to "The Investor's Podcast", where Clay Finck did a value analysis on Dollar General (link here). He did an incredible job and got me interested in examining the company myself. So, I will go through what Finck already covered while adding my own research and analysis of Dollar General.

Dollar General Overview

Turner & Son Wholesale was founded in 1939 in Scottsville, Kentucky, by J.L Turner and his son Cal Turner. The business went public in 1968 as Dollar General Corporation. If we look at the company's KPIs, they focus on the number of stores in the United States. The importance of this metric will be evident as we begin to analyze the company. As of 2021, they have 18,130 stores in 46 states. According to their second quarter report of 2022, they have 18,566, adding 436 stores in two quarters.

Throughout my analysis, I will compare metrics from Dollar General to its following competitors:

• Costco;
• Dollar Tree;
• Walmart;
• Target.

In terms of the number of stores, Costco has 579 in the US in 47 states and territories, Dollar Tree has 7,887 locations in 49 states and territories, Walmart has 4,662 stores in the US, and Target has 1,938 stores in the US. We will dive into more analysis later about these numbers.

Dollar General focuses on providing consumer products to low-income communities, such as food and essential everyday items. Since their target customer is low-income families, they locate their stores in central locations for these families. This strategy is Dollar General's bread and butter; 75% of the US population lives within 5 miles of a Dollar General store. They fill in the gap where Walmart doesn't. Not only do they fill in the gaps, but their prices are also reasonable: they keep prices within 3%-5% of Walmart's prices, as well as 40% lower prices to some of their other competitors, such as Walgreens.

Before we get into the nitty-gritty of my analysis, let's quickly look at Dollar General's market price performance over the years. The current market price of Dollar General is around $250 a share as of the week of November 9th, 2022:

Here are the yearly returns for the last 10 years:

• 2012-11-07 to 2013-11-05 - a yearly return of 21.11%;
• 2013-11-05 to 2014-11-03 - a yearly return of 8.59%;
• 2014-11-03 to 2015-10-30 - a yearly return of 7.40%;
• 2015-10-30 to 2016-10-27 - a yearly return of -0.47%;
• 2016-10-27 to 2017-10-25 - a yearly return of 24.49%;
• 2017-10-25 to 2018-10-23 - a yearly return of 31.46%;
• 2018-10-23 to 2019-10-22 - a yearly return of 50.19%;
• 2019-10-22 to 2020-10-19 - a yearly return of 31.53%;
• 2020-10-19 to 2021-10-15 - a yearly return of -2.42%;
• 2021-10-15 to 2022-10-13 - a yearly return of 13.80%.

If we look at the last 10-year yearly return average, it's about 18%. If we look at the previous 5 years, it's 25%. Thus, market performance is looking excellent, especially recently.

How Finck analyzed the company, he took Buffett's principles and associated them with Dollar General's company. So, this is how we will approach it as well.

Simple and Understandable

One of Buffett's principles about owning a company is the company needs to be simple and understandable. Dollar General fits this principle because of its simple business model: place stores in strategic low-income communities, and provide them with affordable consumables. Not only does this make sense on paper, but they've been successfully doing the same strategy for many years. Dollar General doesn't depend on new technologies or innovations, which dramatically reduces its complexity.

Consistent Operating History

To understand Dollar General's consistent operating history, we will look at its store counts, revenues, earnings per share, profit margin, free cash flow and dividend payout ratio.

First, the number of locations has increased linearly every year for the last 10 years. The number of stores increases by about 6% every year. Thus, their proud metric of increasing the number of stores is consistent.

Let's look at Dollar General's revenue:

Dollar General's revenue has been consistently climbing every year since 1993 and even more aggressively since 2008. Here are the average growth averages of Dollar General's revenue for the following past years:

• Average revenue growth in the last 5 years - 9.45%;
• Average revenue growth in the last 10 years - 8.84%;
• Average revenue growth in the last 15 years - 9.26%.

Dollar General's earnings per share have been growing year after year. However, it is fairly low, currently sitting at around 12. Here is Dollar General's average yearly growth in EPS:

• Average EPS growth in the last 5 years - 18.33%;
• Average EPS growth in the last 10 years - 19.11%;
• Average EPS growth in the last 15 years - 19.94% (adjusted since the 2008 to 2009 EPS growth was a 3000% increase which heavily skews the average).

Dollar General has had excellent gross profit margins in the last 10 years. Moreover, their profit margins seem to stay consistent, not growing or shrinking much at all:

• Average profit margin growth in the last 5 years - 0.45%;
• Average profit margin growth in the last 10 years - -0.030%.

As we can see from the growth, it has been nearly sitting at 0 on average for the last 10 years.

Dollar General's free cash flow has been increasing very nicely in the last 15 years. There has been slower growth and more inconsistent FCF (a huge spike in 2021) in recent years, however. Here a the yearly averages:

• Average FCF growth in the last 5 years - 18.94%;
• Average FCF growth in the last 10 years - 17.17%;
• Average FCF growth in the last 15 years - 23.08%.

The dividend payout ratio seems to be getting worsts year after year in recent years. The average dividend payout is 17.31%, shrinking to about 8.53% yearly.

Favourable Long-Term Prospects

We need to understand if Dollar General has favourable long-term prospects that will persist long into the future. The first metric to look at is the amount of stores Dollar General adds year after year. As we previously saw, the company consistently adds stores and does not look like they are slowing down. Also, apparently, there is more demand for Dollar General stores than the company can fulfill. In 2016, they estimated that the was a potential for 25,000 in the US. As of Q2 2022, they have 18,566 in the US. Over the last 15 years, they have increased their store count by about 6% yearly. Thus, hitting that 25,000 mark will take another 5 years. Hopefully, this potential number will grow, giving them more room for stores. They've also started looking internationally, including opening stores in Mexico, up to 10 stores already as of 2021. Also, 80% of the new stores that open are larger than their average stores, which increases sale growth.

Dollar General also looks at expanding its business segments. They are currently pushing their food segment, which involves selling more fresh, refrigerated and frozen foods. They are also expanding more non-consumable goods to get more exposure in that section. They are also expanding their store locations in more urban areas.

The one idea Finck noted was the shrinking middle class. In theory, since low-income consumers shop at Dollar General, if the middle-class shrinks and more people become low-income class, Dollar General should then have more customers. However, this assumption may be based on the current economic situation with high inflation and high-interest rates. Thus, I will not consider this prospect due to a lack of knowledge and possibly short-term thinking.

Competitive Advantage

Let's look at Dollar General's sustainable competitive advantage. First, Finck notes that the company has a monopoly in small rural communities. Secondly, they have very competitive prices. As mentioned previously, they keep their prices between 3-5% of Wal-Mart's prices, as well as 40% lower than their competitors. Finck also mentioned that the convenience of Dollar General stores' locations is too convenient to shop elsewhere. Thus, Dollar General has created a decent moat around its business.

Management

Buffett looks for management that:

1. Acts rationally;
2. Acts candidly;
3. Managers that resist the institutional imperative.

First, we want managers that allocate capital effectively. This idea means that managers only reinvest in the company if they have high rates of return. If they do not reinvest in the company, they give it back to shareholders either through dividends or share buybacks. Let's analyze their dividend payout, share buybacks and their return on invested capital over the last 10 years:

The behaviour we see in these two charts is precisely what was previously explained. From 2010 to 2017, the company's ROIC was fairly good. Let's look at the company's augmented dividends; it is low, which is to be expected since management decided to reinvest capital into the company instead of directly returning money to shareholders. This strategy is performed in the hopes that the investment will return more value to shareholders than cash over time. However, since 2019's fall-off in ROIC, the augmented dividends have skyrocketed. Thus, management deemed their reinvestment inefficient and wiser to return value to shareholders via money. Therefore, it seems like Dollar General's management is allocating capital wisely.

Another quick note about management is the CEO. Todd Vasos has been the CEO for the last 8 years and has been with the company for 15 years. He will be replaced shortly by Jeff Owen, who has been with the company for almost 30 years. Of course, there is always risk involved when management changes. However, swapping a CEO with someone who has been with the company for a long time is good news for shareholders and the company.

Stock Performance

Let's quickly look at Dollar General's stock performance over the last 10 years. First, let's see if the stock outperformed the market (S&P500):

Let's also compare the annual growth of the S&P500 and Dollar General:

Year Range	Dollar General	S&P500
2012-11-07 to 2013-11-05	21.11%	20.17%
2013-11-05 to 2014-11-03	8.59%	14.33%
2014-11-03 to 2015-10-30	7.40%	7.87%
2015-10-30 to 2016-10-27	-0.47%	3.85%
2016-10-27 to 2017-10-25	24.49%	14.45%
2017-10-25 to 2018-10-23	31.46%	13.17%
2018-10-23 to 2019-10-22	50.19%	7.79%
2019-10-22 to 2020-10-19	31.53%	6.44%
2020-10-19 to 2021-10-15	-2.42%	35.82%
2021-10-15 to 2022-10-13	13.80%	-9.33%

In the last 20 years, Dollar General has beaten the market performance a significant amount of times. On the other hand, there have been a few years where Dollar General did not, and during the start of the COVID pandemic, Dollar General did very poorly. However, one can conclude that, on average, Dollar General's stock performance is good.

Balance Sheet

Let's look at what Dollar General's balance sheets look like. Dollar General's total assets are $26.3 billion, and have total liabilities of $20.1 billion. Thus, their current ratio is 1.31. If we look at Dollar General's competitors:

• Costco - 1.47;
• Dollar Tree - 1.55;
• Walmart - 1.60;
• Target - 1.31.

Compared to Dollar General's competitors, it seems to have a reasonable current ratio. However, it has one of the smallest ones, not by much.

Dollar General has equity of $6.26 billion and debt of $14.24 billion. Their debt-to-equity ratio is 2.27. This ratio is really high, in my opinion. Let's compare this number to its competitors:

• Costco - 0.43;
• Dollar Tree - 1.78;
• Walmart - 1.76;
• Target - 1.25.

If we compare Dollar General's debt-to-equity ratio to its competitors, it has a very high debt.

Finck mentioned something briefly about the company's debt. He believes they brought on a lot of debt because interest rates were very low. The fact that they can launch stores at a low price and high return means they can use debt to generate money beyond what they paid in interest. Their locations are cheap because its in low-income communities. Also, they lease, which reduces their costs as well.

Counter-Cyclical

Finck observed counter-cyclical behaviour in Dollar General's finances. When the market is in a downturn, it seems to do well. So let's see if that is true during 2008-2009 by analyzing its revenue and see if its competitors behave similarly:

• Dollar General from 2007-2009 - 14.04% increase;
• Costco from 2007-2009 - 10.90% increase;
• Walmart from 2007-2009 - 16.34% increase;
• Target from 2007-2009 - 9.17% increase;
• Dollar Tree from 2007-2009 - 17.02% increase.

As we can see from these numbers, they all seem to have increased their revenue from 10-20%. Walmart and Dollar Tree have shown that they do better in downturns than Dollar General. However, Costco and Target seem to not perform as well in terms of revenue during downturns compared to Dollar General. Thus, Dollar General can be counter-cyclical but not as good as some competitors.

Financial Tenets

Let's look at Buffett's financial tenets. First, we need to examine Dollar General's invested capital. As we've seen previously, in the last 10 years, Dollar General's ROIC has been adequate. Secondly, let's look at Dollar General's profit margin. As we've seen previously, its recent profit margin is 31.60%. Let's compare its profit margin to its competitors:

• Costco - 12.15%;
• Dollar Tree - 29.40%;
• Walmart - 25.10%;
• Target - 29.28%.

As we can see, it has the best profit margin relative to Dollar General's competitors, but not by much. We can conclude that Dollar General has a slightly better profit margin than the industry standard (using a small subset of the industry, of course).

We also looked at Dollar General's management, and they look promising. The final analysis to look at is Dollar General's intrinsic value. Finck estimated 18% overvalued with an internal rate of return of 11%. I will do my own intrinsic and relative valuation to assess its value (both methods are described in this post and this post).

First, here are the parameters I used for Dollar General's intrinsic value:

• Risk-free rate - 3.71%;
• Market risk premium - 11.94%;
• Beta - 0.38;
• Growth rate - 13.22%;
• Reinvestment rate - 27.13%;
• Free cash flow after 5 years - $3,419 million;
• Cost of equity - 6.81%;
• Cost of debt - 0.89%;
• Cost of capital - 21.37%;
• Discounted FCF - $18,494 million;
• Estimated intrinsic value - $78.95 / share.

Thus, my intrinsic value demonstrates that Dollar General is actually overvalued by quite a bit. However, this valuation method is rapid that mistakes could have been made.

Now, let's look at Dollar General's relativistic value. First, let's start based on Dollar General's historical performance using a handful of ratios:

We can estimate the potential growth of these ratios:

We can now use these growths to estimate the company's value:

Let's do the same methods, but with Dollar General's competitors' ratios integrated into the calculations:

Dollar General's historical valuation shows that, on average, it is undervalued. This valuation is across the board with 7 different metrics. Using the industry averages, we also either get that Dollar General is undervalued or fairly valued. Thus, our relative valuation demonstrates that Dollar General is undervalued.

Risk

According to the 2021 annual report, here is the list of some the risks to the company:

• Due to the COVID-19 pandemic, there are supply chain disruptions and constraints;
• The economic state might reduce customer spending;
• The company highly depends on increasing sales and profitability, which, if they fail to do so, the company will do poorly;
• Even with their competitive moat, competition is intense and can limit their growth;
• Management's ability to continue their business strategy effectively;
• The pricing pressure from their competitors, such as Walmart.

Conclusion

Dollar General seems to have very excellent prospects and can be seen as currently undervalued. However, its massive debt is a bit of a turn-off. Nevertheless, Dollar General is an exciting company with some potential growth in the future. I will keep my eye on this company and see how it does in the following years.