Dollar General Stock: Thriving Amidst An Inequality Crisis (NYSE:DG)

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Dollar General (DG) is a company that defies the typical retail model. It eschews large stores and scale, targets markets that few major retailers would consider operating in, or are capable of operating in, and avoids competition at all cost. The company’s low-cost business model and skill in capital allocation have enabled it to grow quickly, cheaply and profitably in a part of America that is in secular income decline and desperately needs its services. Whereas analysts think of the company as being a small but significant player in a fragmented retail market, it is more useful to think of it as a dominant and necessary player in an ecosystem of small stores in rural America.

What is Dollar General’s Market Share?

Dollar General employs a unique model that makes me question the utility of market share statistics. According to its Q3 2021 earnings release, the retailer had 17,915 stores in 46 states as of October 29, 2021, compared to 16,979 in the same period in 2020. With some 328,208 brick-and-mortar retail stores in the United States in 2020, that would give Dollar General about 5.5% market share as of October 29, 2021, up from nearly 5.2% in the same period in 2020. I, of course, assume static global numbers. This assumption makes sense given the decline in brick-and-mortar stores generally. Its share of U.S. general merchandise store sales was 4.6% in 2020.

Yet, market share statistics seem overly blunt tools for assessing Dollar General. The company’s record of 32 consecutive years of growth is built on completely avoiding competition and opening stores in small towns in rural America, adding 2.5 new stores a day across the country, in places where it is often the only decent store for miles around. Its stores are strategically placed in areas where there are limited shopping options. In fact, 75% of its stores operate in communities with 20,000 people or less. It looks for places where its market share is absolute. Comparing it to Walmart (WMT), for instance, is foolish because Dollar General typically opens its stores in food deserts, far from a Walmart or the nearest town, and where it can get inexpensive real estate (to lease, rather than buy). It doesn’t compete with Walmart. It merely exists within the same country and industrial space. Where it has competed in close proximity with a rival, such as a Family Dollar (FDO), the company has taken market share, rather than lost it.

Amidst this end-of-times sector, Dollar General has been able to grow. An early 2021 CNN report captures the disconnect of a declining market dominated by a rapidly growing Dollar General: up to that period, 45% of the 3,597 store openings to that point, were opened by Dollar General, Dollar Tree (DLTR) and Family Dollar, with Dollar General alone accounting for a third of new store openings.

DG new stores

CNN

Dollar General’s customers typically make $40,000 or less. These are America’s forgotten, the left-behind who are victims of over a decade of inequality and who for decades have largely been underserved by major retailers. This customer base is growing: between 1971 and 2019, the share of Americans living in middle-income households declined from 61% in 1971 to 51% in 2019, according to the Pew Research Centre. As Chief Executive Officer Todd Vasos explained, “The economy is continuing to create more of our core customers”.

Given the small size of the typical Dollar General store, 10,000 square feet, they are unlikely to face competition from most major so-called competitors such as Walmart, which operate stores of 180,000 square feet, or grocery stores of an average size of 40,000 square feet. These peers do not operate with the same kind of economics as Dollar General. When Walmart took Dollar General on when it opened Walmart Express in 2011, it simply could not compete, and by 2016, the experiment had died, with the company closing 102 stores and selling 42 to Dollar General.

The company’s decision to appoint a Chief Medical Officer is part of its strategy of being the necessary store of rural America by offering services that rural America does not have access to, such as telemedicine, eye care, and prescription delivery to stores. 20% of Americans live in rural areas, but just 11% of those areas are served by physicians. Rural America is less insured than the rest of the country, leading to higher out-of-pocket healthcare expenses. Dollar General is reimagining itself in novel ways to solve problems in rural America.

Protected Against Ecommerce

Dollar General is an ecosystem of monopolies in small towns in rural America. It is this that makes it so impervious to the devastation being visited upon physical stores. Given that rural and lower-income county internet penetration trails national averages and that 22.3% of Americans in rural areas and 27.7% of Americans in Tribal lands lack broadband coverage, compared to only 1.5% of Americans in urban areas, the threat of ecommerce is more muted in Dollar General’s ecosystem. Because most of Dollar General’s goods are food, snacks, cleaning products and home essentials, customers are generally less inclined to buy these products online, anyway.

Low Cost Business Model Fuels Growth

Dollar General’s stores have a limited selection of goods bought in bulk, which allows it to get the best possible prices. Of course, the obvious side-effect of this is a tendency to avoid fresh produce, which has led to criticism that the company is contributing to the country’s health crisis. In response, the company has begun offering fresh produce in its stores.

Because Dollar General tends to lease rather than buy real estate, it can keep its costs very low. Added to that, its stores are lightly staffed, with its over 170,000 employees earning around $16,700, much lower than Walmart, or closer to what a gas attendant earns.

Its store format and size allows the company to set up stores cheaply and quickly, capturing the unfortunately growing segment of America that is getting poorer and still has limited access to decent shopping alternatives. Its store count has exploded from 1,284 in 1991 to 17,915 to-date, compounding at 8.87% throughout that period.

Growing inequality has opened up an opportunity in urban America, and the company has opened stores in cities such as Cleveland and Nashville, where it is capturing the kind of non-traditional customer it never had before: more affluent customers looking for discounts. New chain Popshelf is aimed at affluent women in suburban areas, earning $50,000 to $125,000 a year, and sells more fun items such as party supplies and decorations. This strategy was made possible by Dollar Tree’s decision to stop selling everything for a dollar or less, which hurt the brand’s reputation. So far, Popshelf has been a success. That said, the core customer base will remain shoppers in small towns who do not have other options.

Industry Leading Profitability

The supply-side strength of the company has made it an industry leader in terms of profitability. According to The Wall Street Journal, the company enjoys a 5-year return on invested capital (ROIC) of 15.4%, more than triple Dollar Tree’s ROIC and higher than Target’s (TGT).

Dollar General 5-year average return on invested capital

Wall Street Journal

The company’s business model allows it to expand assets (from $13.2 billion in 2019 to nearly $25.9 billion in 2021) without the typical decline in future returns, because the company keeps investing in markets in which it is the dominant and necessary actor. It is for this reason that I began this piece by asking investors to think of Dollar General not as a small player in a large and fragmented market but as the dominant player in an ecosystem of small, rural towns. Its financial results demonstrate the success of this strategy.

Dollar General has grown revenue from $25.6 billion in 2019 to $33.75 billion in 2020, with revenue for the trailing twelve months (TTM) being $33.9 billion. With growth has come increased profitability. In that period, the company has grown net income from nearly $1.6 billion to nearly $2.7 billion, with TTM revenue at over $2.4 billion.

Management’s Interests Aligned With Shareholders

According to the company’s 2020 Annual Report, 50% of its employee compensation performance share units (PSU) (3-year ratable vest) are tied to 1-year adjusted EBITDA and 3-year adjusted ROIC, split evenly between the two. ROIC drives long-term valuations, and so, tying a part of PSU to ROIC aligns shareholder interests with those of management. Enough has been said about the metric dubbed, “earnings before all the bad stuff”, with Warren Buffett calling it a “very misleading statistic and it can be used in pernicious ways.” It would be better if PSU was fully tied to ROIC, but compared to many companies, compensation is largely rational at Dollar General.

Conclusion

Dollar General has a relentless business model and is trading at a price-to-earnings ratio of 19.8, compared to the S&P 500’s PE multiple of 25.66. The company’s economics suggest that it can continue to grow cheaply and quickly and profitably for decades to come. As inequality widens, the growth runway for the company widens as well. Fears that Dollar General is a counter-cycle company and therefore economic recovery implies dramatically reduced profitability seem off when the inequality crisis continues to plague rural America. Initiatives to offer healthcare options will only deepen the essentialness of the company and widen its moat further.

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