Dollar General (DG) reported financial results for the fourth quarter of fiscal 2018 on Thursday. The company had a solid quarter and year, with comparable store sales increasing 4.0% for the quarter and 3.2% for the year. (It’s worth noting that the fourth quarter number included a 70 basis-point tailwind from the early release of February SNAP payments as a result of the government shutdown). The two-year comp stack in the quarter was the highest number DG has reported in more than five years. In addition, this marked their 29th consecutive year of same store sales growth. As that suggests, DG has delivered impressive results throughout the economic cycle.
Revenues for the year increased 9% to $25.6 billion, with the unit count climbing to 15,370 stores (up 6% from 2017). The company plans on adding another 975 new stores in 2019, which implies another year of 6% growth. This is comparable to unit growth in recent years.
As CEO Todd Vasos noted on the conference call, new store growth remains one of their best uses of capital, with after-tax IRR’s north of 20%. In addition to the traditional stores, Dollar General is also testing a new format called DGX (closer to a convenience store and about half the size of a typical store). While it’s still early days, this may be an interesting opportunity for the company long term that enables it to go after a different customer set.
Considering the outsized unit growth over the past 5 - 10 years, it’s natural to wonder if (or really when) it slows. How can we think about the opportunity for long-term unit growth in North America? This comment from a recent Wall Street Journal article offers some insight:
“In 2013, Dollar General refined its formula for new locations, incorporating such data as proximity to a post office or church. The company identified 14,000 spots, with ‘the highest improvement in opportunities in small town and rural markets,’ Mr. Dreiling told analysts in 2014.”
Considering the company has added about 4,000 stores since then, that leaves room for another 10,000 locations (or about 10 years of growth at today’s pace). Note that this is before considering any opportunities that may open for different formats like DGX.
In addition, while Dollar General has not publicly stated a long-term target, Dollar Tree (DLTR) has said it sees an opportunity for at least 26,000 stores in North America (between its flagship banner and Family Dollar, it currently has 15,200 stores).
Finally, new boxes continue to meet expectations. Its ability to open new stores and attract business speaks for itself (said differently, we would see cracks in the unit economics if we were approaching saturation). While I can understand having some concerns about long-term unit growth – as I do for every company I invest in – I think it’s a manageable concern at the right price.
Gross margins were down 30 basis points for the year, with SG&A (as a percentage of sales) flat. As a result, operating margins declined to 8.3%, with operating profits up 5% to $2.1 billion.
The company benefited from a significantly lower tax rate and share repurchases, with adjusted earnings per share (EPS) up more than 30% to $6.00. Cash flow from operations was up 19% to $2.1 billion. The company spent $734 million on capital expenditures, $307 million on dividends (run rate dividend around $1.3 per share with a current yield around 1.2%), and $1 billion on buybacks (at an average cost around $102 per share, with the share count down 2.6%). Repurchases have had a material impact on the per-share results: Over the past five years, the company has spent $4.8 billion on repurchases (90% of free cash flow) and reduced the diluted share count by around 18%.
Management plans on repurchasing another $1 billion worth of stock in 2018. At current prices (around $110 per share), that’s enough to reduce the share count by another 3% in the coming year.
Like Dollar Tree, Dollar General is investing in coolers (as noted on the fourth quarter call, “this has been one of the biggest traffic drivers and one of the biggest comp drivers we’ve seen"). In 2019, it expects to add another 40,000 cooler doors across its footprint, on top of the more than 20,000 cooler doors added in 2018 (a traditional store has approximately 22 cooler doors and the newest model has approximately 34 cooler doors, implying additions at roughly 1,500 stores this year). These investments have been, and should continue to be, an important growth driver for the company.
2019 guidance calls for same store sales growth of around 2.5%, a slight deceleration from last year (note that the 3.2% result in 2018 compares to initial guidance for same store sales growth “in the mid-2% range”). After accounting for new unit growth, the company expects revenues to be up 7%, with slight margin compression leading to mid-single digit operating income growth. With the aforementioned repurchases, that gets us to EPS growth of roughly 7%, to around $6.4 per share.
It should be noted that management is making investments in 2019 that are a headwind to short-term earnings per share growth. Here’s some of the key commentary from the call:
“Overall, our long-term financial performance goals remain squarely focused on delivering strong growth in net sales, comps, operating profit and EPS, which is also supported by our financial strategies. In some years, we will balance the decision to invest while delivering on our long-term goal of double-digit adjusted earnings per share growth … Our goal is to improve operating profit margin over time, and we believe we are making the right operating decisions and investments to achieve this goal. This year, we'll be making investments in strategic initiatives, including DG Fresh, a supply chain initiative [shift to self-distribute perishable foods], as well as Fast Track, an in-stock productivity and customer service initiative. While both initiatives are still in their early test phase, we believe these investments will allow us to enhance our operating margin profile over the long term. The associated investments, however, will pressure SG&A rates in the near term.”
These two strategic initiatives will add roughly $50 million to SG&A expense in 2019 (equal to roughly 20 basis points as a percentage of revenues). My sense, based on what analysts had to say during the Q&A, is that this is partly why the stock had a difficult day. That analysis is misguided: If shareholders trust management to make sound investment decisions for the long-term health of the business, this is the kind of short-term earnings-per-share headwind they should be okay with (and if they don’t trust management, they probably shouldn’t own the stock anyway). If these initiatives are “meaningfully accretive to sales and operating margin over time,” as Mr. Vasos suggested, they will prove well worth it over the long run.
Conclusion
My financial model assumes 2019 results in-line with guidance. In the out years, I assume roughly 4-5% annual revenue growth and flat operating margins. On both measures, based on the company’s historic results and management’s commentary, I think my model will prove conservative (note that the output is roughly 9% annualized earnings-per-share growth, compared to guidance for double-digit earnings-per-share growth). A terminal trailing price-earnings multiple of 18x gets you to a fair value estimate of roughly $110 per share.
I don’t currently own the stock – but that would almost certainly change if it fell below $100 per share.
Disclosure: None.
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