Dollar General Corporation
An Overly Discounted Discount Retailer
Quick Overview
Dollar General is an American discount retailer that operates a vast chain of stores across the United States. The company's roots trace back to 1939, when Cal Turner Sr. and his father, James Luther Turner, founded J.L. Turner and Son, a wholesale business based in Scottsville, Kentucky. The business initially supplied merchandise to struggling rural retailers during the Great Depression, offering deeply discounted goods. Cal Turner Sr., recognizing the potential for serving low-income communities with affordable products, eventually transitioned the business from wholesale to retail in the 1950s. In 1955, they opened the first Dollar General store, where every item was sold for no more than a dollar, a novel concept at the time. The "dollar" model was highly successful, attracting price-conscious customers and sparking the company's growth.
Now the company offers a wide range of products, including household essentials, groceries, health and beauty supplies, clothing, seasonal items, and more, at various price points and often at lower prices than many traditional retail stores. With a focus on serving rural and low-income communities, Dollar General operates smaller store formats to provide convenient shopping options in areas that may lack access to larger retailers. The company's business model centers around offering value-driven merchandise in easily accessible locations, making it a popular choice for budget-conscious consumers. (Thank you ChatGPT)
Moat
Location, Location, Location
This mantra is the epitome of Dollar General’s moat and a large piece of the puzzle for how the company can deliver high ROIC for an extended period of time. With roughly 80% of Dollar General locations being in small towns of less than 20,000 people, larger players are unable to profitably enter the market. Walmart, for example, requires at least 50,000 people for its massive stores to be profitable. While it may seem that operating in rural small towns doesn’t stop smaller store formats from competing with Dollar General, I’d argue it does. Dollar General is “like a laundromat. If there's already a laundromat in a little town, if you open another one, you just end up killing both.” Actually, it seems like you just killed yourself. Walmart attempted to roll out a smaller concept called “Walmart Express” in 2014 that planned to compete directly with Dollar General in the Southern United States. Two years later, Walmart shut down their locations and ended up selling ~40 of their locations to Dollar General. I will touch on Walmart Express again because it provides other valuable insights.
The rural location also provides insulation from e-commerce and other threats that have collapsed retailers before. Amazon Fresh, for example, has a $9.95 delivery fee for orders under $50, which, when considering the average basket size of $16 for Dollar General, Amazon looks a bit absurd. Furthermore, the product mix of roughly 80% consumables prevents Temu, Shein, or other discretionary retailers from competing with them.
What I find particularly interesting is that the 20% of their stores that are not in rural locations, at least according to management, do not see a drop in “sales results closer or further away from Walmart.” While this may seem strange, Walmart often sells similar or even the same exact SKUs for lower prices than Dollar General. Dollar General serves as a convenience store in those locations and often in urban areas that are considered food deserts or underserved by larger grocery chains. In some areas dollar stores are so pivotal that when they burn down, in the case of a Dollar Tree in Dayton Ohio, residents urge the company “to rebuild because they say the community relies on its low-cost merchandise and food items.”
The quantity of stores and their locations also suggest that the business model is closer to that of a convenience store than a big box store. When speaking with IR, they mentioned that “our customers come to us for a fill-in trip while making the pilgrimage to Walmart for the grocery trip.”
While this is largely an academic exercise, I attempted to quantify some of the advantages that come from being closer to the consumer. Let's assume a Walmart is 30 minutes away. You drive at 60 mph and get 24 miles to the gallon. The average cost per gallon of gas in the US is $3.35, so it would cost $4.19 one way to go to Walmart. Dollar General can effectively sell the same basket of goods for $7 more than Walmart while saving the consumer 45 minutes. This thought exercise is a tad extreme but perhaps helpful in understanding how important location can be and further solidifying the point that Dollar General is more a convenience store than a big box.
The Dollar General Consumer
Understanding the consumer is yet another important point of the thesis and where some people get lost. The Dollar General consumer is poor. For someone like me, almost incomprehensibly poor. 60% of Dollar General shoppers have household income of less than $35,000 annually. 25% of consumers “noted they anticipated missing a bill payment in the next six months,” and 60% claimed they have had to forgo purchasing basic necessities due to a higher cost of living. The few percent cost savings that Dollar General can provide its consumers go a long way. I recently stopped at a Dollar General on my way back from the beach and found Pampers that were $1 cheaper than Target and other necessities that were only slightly cheaper, but still cheaper than competitors.
The Dollar General consumer is unable to pay up for value. So even if a competitor may offer a better "deal,” the additional few dollars required to get that “deal” are most likely not there for the consumer.
A story from Cal Jr.’s memoir, My Father’s Business illustrates this point. Dollar General once replaced a 3-pack of microwave popcorn that sold for $1 with an 8-pack that sold for $2. Cal recounts: “We figured customers couldn’t resist the added value, and we’d be generating a $2 sale instead of a $1 sale. The problem was that popcorn sales fell. Nobody could figure out why it wasn’t a big success. We finally went into the stores and asked, and our people there told us our customers could only afford to spend $1 at a time for something like popcorn."
- Scuttleblurb
Dollar General specializing in smaller unit SKUs (selling 1 sponge per pack instead of 2) gives them an advantage with the extremely cash-strapped consumer. These smaller units increase the frequency at which consumers come back to the stores and potentially buy discretionary items. Dollar General is also able to extract scale advantages despite being smaller than many other retailers because of their specialized SKU mix. Interestingly, Dollar General has the second largest sales per SKU in the retail space behind only Costco, suggesting that, on some products, Dollar General potentially has greater scale advantages than even Walmart. Furthermore, while Walmart is basically required to sell multiple brands in various sizes, Dollar General does not have to, so if a brand does not meet Dollar General’s prices, they simply don’t sell that brand.
The Dollar General business is built to provide value for the lowest-end consumer, and that is something not many companies can compete with. Walmart Express failed largely because it was not specialized in the same way Dollar General was. Walmart’s attempt to make Express just a smaller form of a Walmart Superstore caused them to have dozens of very similar SKUs, increasing logistics costs, while Dollar General might just have one. The costs ended up being incomparable to Dollar General, and the whole project was shut down. If Walmart didn’t even want to battle Dollar General on their home turf, I’m not sure who would.
What Happened?
It has been a rough time for Dollar General. A death by a thousand paper cuts, some self inflected and some not. In 2023 the government cut SNAP, and other government subsidies, hurting the already squeezed Dollar General consumer. The company was forced to write down billions in inventory and saw several hundred million dollars of losses due to shrink, largely because of the shift to self-check out. Dollar General has perhaps always run a little understaffed, but now they are finally seeing the effects of it with merchandise being scattered on floors, shelfs not being stocked, and sometimes no one at the register. Dollar General is feeling squeezed by inflation, much like their consumers, and is unable to offset much of the additional costs causing operating margins to decline to their lowest since 2008.
Additionally, the stock itself was richly valued with many seeing Dollar General as an all-weather or countercyclical retailer. While Walmart is posting substantially better comparables than Dollar General making many think the Dollar General model is fundamentally flawed. The recent company performance has shaken many investors' resolve and caused the share price to decline considerably.
Many are also questioning if management is blaming a harder macroeconomic backdrop for their problems and not taking responsibility for their own actions, and while most of the issues are probably a result of managerial complacency, other companies are pointing to macro as well. Monster Beverage saw a 4.8% decline in sales within the convenience and gas station category in July. Suggesting that consumers are less able to afford non discretionary goods, which is in line with management’s commentary.
Where Are We Going?
Fortunately, I believe that many, if not all, problems that Dollar General is facing are fixable.
Staffing
Admittedly I believe this is a problem that can, at best, only be partially fixed. Dollar General stores have been able to run extremely lean, but as a result, have been unable to properly stock stores and made it impossible for certain ideas to be implemented by management. Even at a district management level managers have been asked to manage 25 stores when they typically only manage 20.
Fortunately, with this rude awakening, Dollar General’s management team has realized they need to do something about staffing. Last year they added an additional $150 million labor hours into their models and “added 140 additional district manager positions earlier this year, to help tighten the span of control for DMs to drive consistency.” The hiring of the additional managers, in my mind, covers much of the issue on the district level, but the $150 million investment in labor hours will most likely only be a fraction of the total labor investment required. That being said, the company is only seeing 4% wage rate inflation for the year.
Distribution
Dollar General has been working on this for the last several years and part of the reason for being able to sustain gross margins while shifting to consumables. Bringing trucking in house produces a “20% cost savings every time [they] convert to a private tractor.” With only slightly more than half of their outbound transportation being done privately, there is still ample room to achieve cost savings from trucking.
The botched roll out of DG Fresh and expansion of the DC network is also unwinding. 11/12 of the temporary DC facilities that Dollar General opened are already closed and the last one will be closed by the end of this year. In their place Dollar General is building 2 DCs which will lower operating costs. The number of stores per DC is almost 300 lower than what management thinks they are capable of managing, meaning that Dollar General will have to commit less capital to fund their growth in the future.
Dollar General is also changing their sorting process at these DCs and how they pack their trucks to reduce the load on the store employees. Which will lessen employee expenses in the future. OTIF levels (on-time in-full) are significantly higher than the year prior suggesting that the changes to the sorting process have been effective. Dollar General is also removing 1000 SKUs by the end of the year, which should further simplify the distribution process.
Merchandise & Market Share
Despite the botched roll out of DG Fresh, the company is seeing some gross margin lift. Dollar General has historically had a consumables mix in the mid 70% range, only recently surpassing 80%, so if the mix were to normalize, the higher margin seasonal, home products, and apparel segments would further boost margins. Furthermore their increasing efforts in private label and health/beauty products provide some gross margin lift as well. The additional labor hours, and shifting back from self checkout to assessed check will help reduce shrink. On the most recent management call, they specifically mentioned that they “are cautiously optimistic that we will see shrink begin to turn to a tailwind later in Q4 and then become a more material tailwind in 2025.”
While some reports are suggesting that Walmart, or even Temu, are taking market share from Dollar General, it seems to be the opposite. On the most recent call management stated that “we're actually gaining share against all classes of trade in the consumable realm... We're not seeing any one competitor, mass or anywhere else, take our core customer.” The cash payback period still continues to be less than 2 years with IRRs of 18% for new locations.
Management
My feelings about management are mixed. Mr. Vasos returned to the CEO position in 2023, replacing Jeff Owens, to try and get the company “back to basics”. I struggle to solely blame Owens for the situation of the current company, he was the CEO for only a year after all, and Vasos was there for much longer.
Vasos was the CEO of Dollar General from 2015 to 2022, so while he does have tremendous experience he was largely executing the playbook already outlined by Rick Drieling, the CEO prior to Vasos. Fortunately it's a winning one, but this new environment may be more difficult to navigate than before. The fact that compensation is tied to ROIC, with a threshold of 20.59%, still gives me confidence that management will act rationally. Additionally, what they have done already to navigate some of the recent challenges is promising.
While many are bashing the share buyback program that Dollar General had implemented, I think it's largely hindsight bias to say that was a bad idea. However, stopping the buybacks entirely while the stock price is at a 7 year low is a little perplexing. I’d like to see them restart the buyback program sooner rather than later.
Management does seem fairly confident about the company with Vasos saying: “I would tell you that we believe this business is going to return to a 10% to 10% plus EPS growth on an adjusted basis over the longer term.”
Competition
Walmart is the big bad woof that everyone believes will blow down the straw house of Dollar General, but as I alluded to earlier with Dollar General being more of a convenience store than a big box store and management not seeing Walmart take share or impact local Dollar Generals, Walmart is closer to a compliment of Dollar General than a competitor. Instead I find Family Dollar to be the primary competitor to Dollar General.
In 2014 Dollar Tree acquired Family Dollar for 11x EBITDA and it's been floundering since. Family Dollar had, and still does have, a similar consumables mix to Dollar General with roughly 75% of sales coming from consumables. Dollar Tree’s management seemed oblivious to problems occurring within Family Dollar and until recently its been a total shit show. Unfortunately for Dollar General, Dollar Tree recently hired Rick Drielings, former CEO of Dollar General, to get the company turned around. I’m not super worried because of the aforementioned laundromat example and Dollar Generals being able to coexist with some Family Dollars, but something to note.
Convenience stores are another competitor to take note of; however, to me, it seems that many convenience stores are becoming more premium and out pricing the lowest end consumer that Dollar General serves. Wawa, the most famous convenience store in my area, sells a dozen eggs for 75 cents more than Dollar General. Additionally their food offerings are just too expensive for the ultra low end consumer. Most convenience stores don’t stock the same SKUs either, so while you could visit a convenience store for a snack, cigarettes, and some batteries, you would have to go to a Dollar General for anything more substantial.
Growth and Optionality
Despite having almost 20,000 locations in the US, there is plenty of growth left for the core Dollar General store. California, for example, has 33% more people and roughly the same number of small towns as Texas, but Texas has almost 7x as many Dollar Generals.
Nevada, Utah, Montana, Idaho,and Wyoming hardly have any locations at all. The economics of these locations will most likely be worse than average though due to longer supply lines and such. Nevertheless, there is plenty of growth to be had for the core concept.
Dollar General also has three locations in Mexico that perform better than the average US location, and while management has not given indication that they will be investing in this area soon, it does provide an additional interesting growth avenue. I would suspect there to be more competition in Mexico though primarily due to OXXO stores. OXXO is a Mexican convenience store with almost 23k locations and serves 12 million people daily. Regardless, it is an interesting opportunity to consider, but not factor into any growth assumptions.
Similarly, Dollar General has about 230 pOpShelf locations in the US, which primarily sell home decor, health and beauty items, and party items. It is advertised as a more fun and vibrant store designed to compete with Five Below in urban markets. In light of the struggles with the core Dollar General concept management is not putting additional capital into the concept and has yet to disclose store level economics, which makes me think they might not be very good. If they were anywhere close to Five Below I’d expect them to be bragging about it on every earning’s call.
Valuation
Store remodelings provide an 8-10% comp lift in the first year, which, assuming they remodel 1600 locations per year, results in around 0.6% growth in revenue per year. New unit growth adds 3.5% to the revenue growth per year, so from remodels and unit growth, revenue should grow around 4%. Dollar General had same store sales growth of 2.7% prior to the pandemic, so with a slight slowdown to 2%, total revenue should grow 6%.
Interest expense should continue to decline as management focuses on paying down debt rather than buying back stock. With LTM FCF of $1.6b there is ample cash available.
Prior to the pandemic, Dollar General had margins of 9-10%; however, with SG&A increasing at 8% annually, primarily due to wage inflation, I don’t see margins returning to their pre-pandemic levels. Assuming that management is able to solve most of the current issues, 7% margins seem probable. This assumption is not out of left field either. In 2007, Dollar General was faced with a very weak lower-class consumer without any trade down from the middle or upper class, making their issues seem specific only to the dollar store format. However, as the economy worsened and consumers began to trade down, Dollar General’s operating margins reached 9.5% in 2009, and the issues that once seemed to be facing the company turned into tailwinds. Unfortunately it's impossible to exactly determine the future operating margins of the company due to management’s relatively limited disclosures, but given historic trends and the current company initiatives I still believe 7% operating margins is a fair, if not slightly conservative, estimate.
Thus, in five years, with 7% operating margins, 6% revenue growth, $200 million in interest expenses, a 23% tax rate, Dollar General should be worth roughly $41 billion in 5 years at 15x earnings. The base case here provides a 17% IRR without accounting for any dividends or potential share buybacks once they get their debt levels under control.
Other Scenarios
The switch from looking at operating margins to gross margins here is to assume management is unable to fix the current issues facing the company. I just found it easier to account for unforeseen initiatives within the company by using operating margins above.
If management is able to fix their gross margin issues and return gross margins to 31% but is unable to offset SG&A issues, the outcome is still fair. Assuming 5% revenue growth, 31% gross margins, a 30% rise in SG&A expenses, interest expenses staying the same, and a tax rate of 22%. In year 5, Dollar General produces $1.65b in net income; at 14x earnings, the 5-year IRR would be 4%. When accounting for dividends and potential buybacks, the IRR rises to 7-10%.
If, for the next 5 years, revenue grows at 4%, gross margins remain depressed at 30%, SG&A expenses rise 30%, interest expense remains roughly constant, and the tax rate is 20%. Dollar General will produce $1.3b in net income. At a 12x multiple that results in a market cap of $15.5b or a -3.8% IRR over those 5 years from the stock. Assuming that management never restarts buybacks, the 2.8% dividend yield brings returns to a -1% IRR over 5 years. While this is terrible, this is basically if everything bad that can happen, happens.
Somehow, if management is able to work their wizardry and operating margins return to 9%, with the same assumptions and 17x earnings, Dollar General would be worth $60b, a 26% IRR before dividends and share buybacks. When accounting for yield, the returns could be in excess of 30%. While this does sound spectacular I would be shocked if management can pull this off.
Anyway I’m so back! (I’m going to go into hibernation again ChemE is hard)
Guys he’s back
Well researched.