No. of Recommendations: 22
Not sure what you are suggesting; DG is down about 20% from its recent high (in March) but still up 25% from the bottom last October. I think for most of us that bought at the "low 100s" the investment thesis hasn't changed much, I still expect to be able to exit above $175 / share - which would be a nice return.Over the last 12 months the net margins have fallen steadily, quarter after quarter, from 6.2% to 3.8% now.
They claim much of the reason is increased theft, and are adding staff to replace automatic checkouts, but the extra staff also has a cost. Note: Even without this extra staff, their net margins are down to 3.8% today. Their average margin over the last 15 years has been around 5%, so we are not talking about a dramatic difference - but what is striking is the rate of decline in the margin on a quarter to quarter basis: Over the past quarters, starting from teh most recent: 3.8%, 4.3%, 4.9%, 5.6%, 6.2%.
The balance sheet is not dangerous, however it also disrupts the value significantly and should be accounted for in the valuation. Their market cap is $28 billion, and their enterprise value is $46 billion. So their net debt is $18 billion. With the unexpected rise in rates (looking at this from five years ago), I think they are doing the right thing to re-direct buyback plans to reducing their debt, as it is a much larger burden than it had "planned to be" prior to the rate rises. It is especially important to get the debt burden down given that their margins may remain low for a whilst (or maybe not, but you want to survive in either case). Low margin business having with a lot of debt is not a good look for investors.
Low margins firms can be a little precarious regarding the observable value also. Dollar General's net margins are only 3.8% now, so if - for example - they continued to fall by another 2%, the EPS will more than half and the PE would jump from 18 to over 40, which would start to really scare the value focussed investors. I am not suggesting that is what I expect, but just that when the margins are low, small changes in the margin have a leveraged effect - both negatively, and thankfully also positively.
Return on equity fell from 40% four years ago to 22% today. Although, it averaged only about 25% over the last 15 years, so it is around normal. Again, the worrying thing is the rate of decline in the margin.
Now for the good news.
Sales per share grew by 70% over the 4 years since the start of 2020 (over 12% per year). Not bad, but they have to do something with their earnings (and an average ROE of 30% over the 4 years) and they have been using earnings to build more stores. Their business model is very suited for growth as their stores are amazingly cheap to set up.
Main sources of sales per share growth over the 4 tears: (1) Using their earnings to build more stores, (2) inflation adding about (at a guess) 5% per year to selling prices, (3) buying back 12% of their stock, adding another 3% per year.
Also, listening to the last couple of earnings calls, the management is very enthusiastic about things improving later in the year, for example the CEO said "Discretionary side of the business to get healthier in the back half of the year", and the CFO continued "We are looking forward to strong top line and bottom line growth in the back half (of the year)". This is mostly my ignorance, but I just have to add that I didn't hear a convincing argument as to how. They expressed that things are going to get better, but the reasoning was a bit vague - I'm not saying that I don't trust them, but it would be nice to understand what is going on. The CEO gave added, "All the work we are doing with back to basics, it will continue to gain momentum, many of those opportunities directly effect the shrink line ... too much inventory always leads to additional shrink, so we continue to watch that carefully .. we believe we have the right amount of labor hours in our stores at the moment, and saw a 30% increase in our average hourly rate .. and we added 120 district managers who are able to teach, train, develop and solve problems, and that should pay dividends .. (paraphrasing) this will allow the checkout to better attended .. we feel good about all the investments we have made and where we are".
In summary:
(1) They are definitely lowering the inventory to be more easy to manage, and they believe that will also reduce theft though I don't personally understand the realistic relation between inventory levels and theft.
(2) They have already hired 120 district managers, and I presume this also helps the notorious empty cash registers to be attended, as well as problem solving to be better as the CEO said. But why were they so understaffed the last few years?
(3) Checkouts to always have someone attending, and generally removing self-assisted checkouts.
Just to put some water on the stove for a moment, the list below is a reminder that retail is hard. It lists all the retailers that went bankrupt. This list doesn't include many firms that still exist but were reduced from giant sized to peanuts, such as Kmart.
https://en.wikipedia.org/wiki/List_of_defunct_reta...
Dollar General's main competitive advantage is selling in remote regions where there is no other economy-of-scale competition. (We can't use the economy of scale, of itself, as a major advantage, as the traditional competitors had that also - but still died, such as Kmart becoming large but losing its business to Walmart).
I studied how Kmart declined, and frankly they didn't do anything particularly awfully but just were outcompeted. They had a certain shopping experience the customers liked, and at one stage they tried to modernise and there were reports that customers felt it has lost its earlier soul (for example they stopped the 'blue light specials' and outsourced the kitchen, so it felt foreign and less friendly). Also they gave possibly too much priority to expansion, debt also getting out of control, rather than controlling margins control to stay more profitable. The latter is why I actually like Dollar General's decision to prioritise reducing their debt - remember, their market cap is $28 billion, and their enterprise value is $46 billion, and net debt is $18 billion. If you are looking to buy Dollar General as a private buyer, you really notice the debt debt, which is why many investors calculate the PE using the enterprise value rater than market value. In the case of Dollar General, the difference is pretty stark (to do this properly you need to adjust the earnings for debt interest, but ignoring that the PE is today 19, which jumps to a PE of 31 based on the enterprise value). Let's get that debt down!
Perhaps for Dollar General, it boils down to good old fashioned business decisions. Everything that I heard from them in the last quarter Q&A seemed sensible, even if not as "next industrial revolution" shattering as Nvidia's latest call.
- Manlobbi
