Why Has Dollar General Lost Its Mojo?

Price Target $65.00
Link to Newswire Release
August 31, 2016

In December of 1956, the great Mississippi bluesman Muddy Waters recorded one of our longstanding favorite songs, “Got My Mojo Working.”  The song begins: “Got my mojo workin’ but it just don’t work on you.”  That just about sums up our sentiment towards Dollar General Corp (NYSE:DG).  Its “mojo” is certainly not working on us here at Street Watchdog.

Five years ago, the stock was trading in the mid $30s; last month it was trading in the mid $90s.  A 200% return over a 5-year period is stellar in today’s market.  Last week when the company reported its second quarter results for this year, the stock tanked by 18% overnight and has fallen even more since then.  Clearly its “mojo” is not working on the broader market either.  Is this a “buy the dip” scenario, or can we expect the stock price to fall even further?

We expect Dollar General has further to fall for several reasons:

1.  The company’s quarterly revenue growth rate was slower this quarter than in any of the prior 6 quarters (see below):

In 2014-Q4, quarterly revenues grew by 9.90% over the same period of the prior year (QOQ)
In 2015-Q1, quarterly revenues grew by 8.77% QOQ
In 2015-Q2, quarterly revenues grew by 7.87% QOQ
In 2015-Q3, quarterly revenues grew by 7.25% QOQ
In 2015-Q4, quarterly revenues grew by 7.04% QOQ
In 2016-Q1, quarterly revenues grew by 7.05% QOQ
In 2016-Q2, quarterly revenues grew by 5.81% QOQ

Does a pattern begin to emerge here?  Quarterly revenue growth has fizzled down to 5.81% this most recent quarter from 9.9% in 2014-Q4.  That by itself is cause for concern, but more importantly, this trend is expected to continue.  We will discuss that in more detail later in this report.

2.  Over the same prior period of time, the company’s rate of growth in quarterly profits averaged 11.02%.  This most recent quarter, the profit growth rate was 8.56%.  Clearly the momentum is slowing.

3.  The company is facing multiple headwinds, one of which is heading into a recovery (which is bad for dollar stores) with a much weaker balance sheet than it had last year.  At the end of its 2015 fiscal year, Dollar General had nearly $580 million in cash.  That cash balance has been whittled down to $185 million on its most recent balance sheet.  During the same period of time, its current liabilities have ballooned from $1.96 billion at the end of FY 2015 to $2.72 billion currently.  Less cash...more debt...that alone speaks for itself.

4.  The company missed expectations on both the top and the bottom lines.  The Q2 EPS of $1.08 was $0.01 worse that the analyst estimates of $1.09 for the quarter.  More importantly, revenues for the quarter came in at $5.39 billion versus the consensus estimate of $5.5 billion.  Comparable sales increased by 0.7%, well below the 2.6% growth analysts were expecting, due to fewer shoppers at Dollar General Stores.  In contrast, retail giant Wal-Mart (NYSE:WM) said shopper traffic rose at its U.S. stores for the eighth straight quarter, helped by aggressive pricing that boosted its grocery business, which accounts for 55% of Wal-Mart’s business.  Results can also be seen from Wal-Mart’s efforts to upgrade its fresh food area.

5.  Dollar General has had to cut prices by 10% on about 450 of its best selling items such as bread, eggs, and milk across 2,200 stores during the quarter, according to CEO Todd Vasos.  This price war has been in an effort to win back market share from Wal-Mart.  The price cuts are expected to extend to more product categories across more markets according to CEO Vasos.  Larger rival Dollar Tree, Inc. (NASDAQ:DLTR) also reported lower-than-expected sales.

6.  Price deceleration is pinching both sales and profit margins.  Dollar General said prices fell by 8% and 50% over the quarter for milk and eggs respectively.

7.  Earlier than expected cuts in food stamp benefits is also pinching both sales and profit margins.  From 2012 to May 2016, over 4 million people lost their food stamp benefits.  This year, seven states, all governed by Republicans, ended food stamp benefits earlier than they had to.  By some estimates, another 500,000 persons will lose food stamp benefits by year end, disproportionally hurting dollar store shopping.

8.  Dollar stores run counter cyclical…meaning that as the economy improves, their sales decline as shoppers frequent higher end stores.  The jobs numbers and the economy in general have both been improving steadily this year, so much so that the Fed is talking about a rate hike by year’s end.

Given the headwinds facing Dollar General, we do not believe it should be trading at a premium to Wal-Mart, quite the opposite.  It appears Wal-Mart should now be trading at a premium to Dollar General.  In looking at the trailing PE for the last 4 quarters for both stores, Wal-Mart is trading at 15.14, and Dollar General is trading at 17.68, based on yesterday’s closing prices.  Given that Dollar General should no longer command a premium to Wal-Mart, at a comparable trailing PE of 15.14, a more than fair valuation for Dollar General would be $64.80. 

Disclosure:  We are short DG.  We do not have a financial relationship with the company.