To The Moon

$Dollar General(DG)$

Let's dive into why super investors are heavily investing in Dollar General stock right now. Is it simply because the stock is trading near its 52-week low? Could it be tied to the return of Todd Vasos as CEO, who came out of retirement last year to lead the company? Or is there more to the story? Today, we'll use our seven-step analysis process to explore these questions in detail.

Overview of Dollar General

Dollar General is the largest discount retailer in the U.S., operating approximately 20,000 stores. On average, the company opens three new locations daily, primarily targeting towns with populations under 20,000 and household incomes below $40,000. Their business model revolves around offering everyday essentials at competitive prices.

Stock Performance

Dollar General's stock price has plummeted 70% from its peak at the end of 2022, including a 45% drop last year alone. A 70% discount in stock price often comes with challenges, and Dollar General is no exception:

1. Understaffing Issues: Cost-cutting led to fewer employees, making theft easier and resulting in the loss of 1% of annual revenue.

2. Customer Experience: Poor staffing contributed to dissatisfied customers, prompting the company to raise wages and hire more employees, which increased operating costs.

3. Store Remodeling and Relocation: These efforts generate significant expenses but aim to position the company for long-term growth.

Past Performance If you had invested $1,000 in Dollar General 10 years ago, you would have acquired about 15 shares. Today, those shares would be worth approximately $1,114, plus $190 in dividends, for a total return of $1,304—a modest 30% gain over a decade. However, if sold near the peak two years ago, the return would have been closer to 270%.

Ownership and Insider Activity

• Insider Ownership: Individual insiders own just 0.3% of the company, well below the desired threshold of 2%.

• Insider Transactions: There have been more sell transactions than buys among insiders.

• Super Investor Ownership: Four notable super investors, including Seth Klarman and Christopher Bloomstran, have Dollar General in their portfolios. All four increased their positions last quarter.

Earning Overview

Dollar General has seen a recent decline in its earnings per share (EPS). This drop is part of a broader trend where the company is facing financial pressures due to several factors, including rising operating costs, underinvestment in labor, and significant costs associated with remodeling and relocating stores. These investments are aimed at positioning the company for future growth, but in the short term, they have put a strain on the financials.

The drop in EPS raises a key concern for investors: whether the company’s growth strategies will pay off in the long run or if ongoing challenges—such as increased labor costs, regulatory pressures, and competition—could keep EPS growth in check. If the investments being made now (such as store renovations and staffing improvements) do not lead to significantly higher revenues or cost efficiencies in the future, the decline in EPS could persist.

Fundamental

1. Return on Invested Capital (ROIC): A strong 13.4%, well above average. Good

2. Net Profit Margin: Solid at 6.3%, compared to a sector median of 4.2%. Good

3. Share Buybacks: The company repurchased 32.1% of its shares over the last decade. Good

4. Debt Levels: It would take 3.5 years of free cash flow to pay off long-term debt, which is higher than the preferred two years. Bad

Growth Metrics

1. Revenue Growth: A 10-year compound annual growth rate (CAGR) of 8.3%, slightly below the desired 10%. Bad

2. Free Cash Flow Growth: Negative 3.2% over the last decade, largely due to heavy reinvestments in the business. Bad

3. Earnings Per Share (EPS) Growth: A 10-year CAGR of 9.1%, just shy of the 10% target. bad

Guidance

Dollar General plans to remodel over 4,000 stores in fiscal 2025, representing significant upfront costs but also setting the stage for future growth. Super investors appear to believe in the company's potential despite recent challenges, likely banking on its strategic investments to pay off over time.

Ultimately, while the stock has faced considerable headwinds, its long-term prospects might still hold promise, especially for those willing to take a patient, forward-looking approach.

Free Cash Flow

Dollar General's free cash flow (FCF) performance has been somewhat concerning in recent years. The company has experienced a decline in free cash flow growth, with a negative 3.2% growth rate over the past decade. This decline is primarily due to significant reinvestments in the business, including store remodeling and relocations, which require substantial capital expenditures.

For fiscal 2025, Dollar General plans to remodel over 4,000 stores, which is a costly initiative. While these investments are designed to drive future growth, they create short-term pressure on free cash flow. Essentially, the company is investing heavily in its infrastructure and operations now, which has resulted in a reduction in the amount of free cash flow it can generate in the present.

This decline in free cash flow is a red flag for investors, as it can limit the company's ability to return capital to shareholders, reduce debt, or reinvest in other growth opportunities. However, the expectation is that these investments will eventually lead to higher revenue and profitability in the future, improving free cash flow in the long term.

In summary, while Dollar General's free cash flow performance is currently weak, it is largely due to heavy capital expenditures aimed at revitalizing the business. The key question is whether these investments will result in a strong rebound in free cash flow down the road.

But are they also returning earnings to shareholders?

The dividend yield stands at 3.1%, meaning shareholders can expect to receive $236 annually for each share they own. The payout ratio is 31.3%, which is within the healthy range of 20–50%, making it quite attractive. Additionally, the 5-year dividend growth rate is 20.7%, signaling strong growth in shareholder payouts.

Risk And Challenges

Labor Costs and Staffing Issues

Rising Labor Costs: One of the key challenges Dollar General faces is increasing labor costs, especially as minimum wage laws rise and the company is forced to raise employee wages to improve staffing levels. This increases operating costs and could erode margins.

Staffing Shortages: Inadequate staffing has been a significant issue, leading to lower customer satisfaction and higher theft rates. The company is addressing this by hiring more employees, but this also comes with the added cost of higher wages and additional employee benefits.

Competition

Rising Competition: Dollar General faces intense competition from other discount retailers, such as Dollar Tree, Family Dollar, Walmart, and even e-commerce giants like Amazon. The low-cost retail segment is crowded, and maintaining a competitive edge is crucial.

Online Shopping Trends: The rise of online shopping could also hurt brick-and-mortar stores like Dollar General, especially as customers increasingly turn to e-commerce for convenience and competitive pricing. While Dollar General has focused on smaller, rural stores, it still faces potential disruption from digital retail.

Debt Problem

Debt-to-Cash Flow Ratio

It would take 3.5 years of Dollar General’s current free cash flow to pay off its long-term debt. This is above the preferred threshold of two years, which would typically suggest a more manageable debt load.

While not alarming, this higher-than-ideal debt-to-cash flow ratio indicates that the company is more leveraged than some investors might prefer, and it could limit financial flexibility in case of a downturn or other financial strain.

Rising Interest Rates

If interest rates continue to rise, the cost of servicing debt could increase for Dollar General, adding pressure to its financials. This could further strain its free cash flow, as more money would be allocated to interest payments rather than reinvested into the business or returned to shareholders.

Valuation

While the dividend looks appealing, it's time to address one of the most crucial questions: Is the stock undervalued? With a price-to-earnings ratio of 12.6, it's not bad, but to determine the intrinsic value of the company, we'll use a discounted cash flow (DCF) analysis. If you're interested in learning how to value companies using the four most commonly used models, check out the Company Valuation course at Stock Investing Academy.

Now, let's estimate Dollar General’s growth over the next decade with three different scenarios:

• Low Growth: 3% for the first 5 years, followed by 2% thereafter.

• Medium Growth: 5% for the first 5 years, then 4% after.

• High Growth: 7% for the first 5 years, then 6% after.

The low scenario reflects industry expectations of 2% growth over the next few years, the medium scenario assumes Dollar General outperforms its peers, and the high scenario reflects the company’s past growth trend, albeit at a slightly slower pace. Based on these growth estimates, the intrinsic value for Dollar General is:

• Low scenario: $76

• Medium scenario: $91

• High scenario: $119

Applying a 30% margin of safety to these values:

• Low scenario: $53

• Medium scenario: $64

• High scenario: $76

Investment Thesis

With the current stock price around $75, Dollar General seems close to its fair value. However, before making any investment decisions, let's look at the bigger picture. Dollar General offers an attractive dividend and is a stable business, doing well in tough times when customers seek bargains. It is also making strategic investments to drive growth, which could bode well for its future. Furthermore, the company is buying back a significant number of shares.

On the downside, the company's debt load is substantial—while not alarming, it's worth considering. Additionally, labor and regulatory challenges, such as potential increases in the minimum wage, could pose short- and long-term risks.

Conclusion

Now, let’s review Dollar General’s stock ranking. Investor sentiment and dividends are strong, and financial health appears decent, but growth is less impressive. When we look at revenue, it’s growing steadily, so if that were the only focus, the outlook would be positive. However, the decline in free cash flow and recent drops in earnings per share suggest some caution. The big question is whether the company’s investments—those causing the free cash flow dip—will drive enough growth in the long run to make the strategy worthwhile, or if the discount retail model may struggle due to rising labor costs.

While Dollar General is not in immediate danger due to its debt, its debt load and free cash flow challenges represent risks that investors should monitor closely. The company's future ability to manage its debt effectively will depend on the success of its growth investments, the sustainability of its cash flows, and broader economic conditions (like interest rates and labor costs).

What’s your take on the situation? Do you believe in the company's growth prospects, or do you think the model may face challenges in the future?

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