Dollar General: A Case Study

Financial Analysis

A brief overview of Dollar General’s (DG) current corporate governance will show one main difference from its competition. The company was acquired by a private equity buyout completed by Buck Holdings, L.P. during July of 2007. Buck Holdings is a Limited Partnership controlled by Kohlberg Kravis Roberts & Co., better known to the investment world simply as KKR. The company was brought public with the help of Goldman Sachs & Company (GS) during an initial public offering (IPO) of 39.2 million shares at a per share price of $21. As a result of the private equity transaction Buck Holdings, KKR and Goldman indirectly own 85% of Dollar General shares. This allows the three companies to control the board of directors at Dollar General, which relieves them of certain corporate governance requirements, and have complete discretion of board members (Standard & Poor’s 2010).

Reuters and Standard & Poor’s research indicates that today Dollar General is in a good place relative to the retail industry and is benefiting from trends in the current economic environment. The market closing price of $33.01 was booked on November 24, 2010. Including the fiscal year end of 1/29/10 and the current TTM (Trailing Twelve Months) the company has shown growth in sales at 8.29% over the past five years. The current price-to-earnings ratio of Dollar General varies in a range from the low to mid 20s TTM as of late (Standard & Poor’s 2010).

Financial Ratios and Company Comparisons.

Income Statement Summary			All numbers in thousands.
Period Ending		2010	2009
Total Revenue
Dollar General		11,796,380	10,457,668
Family Dollar		7,866,971	7,400,606
Dollar Tree		5,231,200	4,644,900
Gross Profit
Dollar General		3,689,871	3,061,097
Family Dollar		2,808,000	2,578,205
Dollar Tree		1,856,800	1,592,200
Net Income
Dollar General		339,442	108,182
Family Dollar		358,135	291,266
Dollar Tree		320,500	229,500

			Dollar General	Dollar Tree	Family Dollar
Growth Rate TTM			(DG)	(DLTR)	(FDO)
Market Cap			$11 Billion	$7 Billion	$6.3 Billion
Market Price			$32.31	$55.92	$50.31
52-Week Change			36.85%	46.40%	46.90%
Price/Earnings			25.34x	19.34x	19.15x
Managed Effectiveness TTM
Return on Assets			4.80%	16.28%	12.22%
Return on Equity			13.14%	27.02%	25.03%
Return on Invested Capital			5.56%	21.09%	18.37%
Financial Strength MRQ
Debt/Equity			0.91x	0.19x	0.18x
Inventory Turnover			5.15%	4.15%	5.01%
Profit Margin			3.54%	6.47%	4.55%

Income Statement Information and Ratios obtained from (Reuters Company Reports, 12/1/10) & (Dollar General, Family Dollar and Dollar Tree

Financial Ratios Explained

Dollar General's debt-to-equity ratio indicates that it has been as aggressive with using debt to finance growth compared with its peers in the discount retail industry. The result is an effect on the company’s earnings that is similar to Family Dollar and Dollar Tree (Reuters Company Research 2010).

Dollar General's P/E Ratio is greater than 88% of other companies in the discount retail industry. Investors should be willing to pay more for its level of earnings relative to the company’s growth in the future. Investors have little choice in the matter with Dollar General’s P/E Ratio the highest of the three companies in this comparison by several times. Dollar General's earnings per share (EPS) growth rate, is greater than 61% of its peers in the discount retailer industry (Reuters Company Research 2010).

In stark contrast the Return on Equity (ROE) percentage for Family Dollar and Dollar Tree shows those companies are much better at reinvesting earnings than Dollar General. Typically, companies that have higher return on equity values are more attractive to investors (Reuters Company Research 2010).

Debt to Equity is the highest for Dollar General compared with the two other competitors. Its 0.91 times shows how it is using debt to its advantage in growth plans. The company should be able to grow future earnings at a higher rate than its competition. This is a benefit to shareholders and the likely reason why the company’s P/E Ratio is higher than Dollar Tree and Family Dollar.

Financial Trends Summary

Financial trends across the industry in comparison with Dollar General are generally an area where the company can improve upon. The sales growth for Dollar General over the past five years has met the industry averages. It has also managed to outpace the rest of the industry more recently in the trailing twelve months. The company’s earnings per share growth has also outpaced the competition. Profitability ratios, based on percentages, show a company lagging the industry. Gross margins, operating margins and net margins are all lower against the industry averages over the past five years and TTM. Typically Dollar General ranks in the middle of the pack in profitability, including other companies than the three in this study, over the past five years and the TTM. Management effectiveness regarding ROA, ROI and ROE are all slightly below the industry rankings but are in the 60th percentile, on average, for the aforementioned return ratios. Financial strength, when measured against the discount retail industry at a whole, is not nearly as strong as it appears against only Dollar Tree and Family Dollar. The company only manages to be in the 33rd percentile of its Debt/Equity. This is an area that is market specific to the dollar-type stores. In general the company is outperforming (Reuters Company Research 2010).

No single financial ratio can tell the whole story in terms of a company’s growth. The company is growing jobs and not just financial returns. A recent article by finance writer Amey Stone, Editor of Daily Finance from AOL, discussesthree companiesthat are hiring in the current economy. UPS, Google (GOOG) and Dollar General are the three she discusses. These new jobs include not only part-time and seasonal workers but Dollar General is also hiring managers to run the several hundred new stores the company plans to open in the next year.

Recommendations

The current situation in commercial real estate would appear to be the single largest factor where Dollar General can gain profitability and market share. Going forward with growth during an economic downturn would be beneficial toward an average company that excels during a growth cycle. Dollar General in turn should excel more during the actual downturn. This would be the opposite of a boom cycle and how a typical company would grow its capital expenditures and assets.

A company that needs real estate to develop and room to grow sees no better time than during a downturn. Typically low interest rates to spur the economy are also advantageous to a growing company for two reasons. The first reason is there is little opportunity cost lost with tying capital up in real estate holdings with low interest rates. The second reason is that it becomes financially sensible to leverage the transaction with borrowed money. A company such as Dollar General would be better served expanding when the industry, in particular, is seeing a downturn. Expansion during boom times of industry specific sectors typically leads to overproduction, or in the case of retailer, overexpansion. If commercial real estate prices have yet to “bottom,” and by anyone’s best guess this is still unknown, then it would an opportunity for the company to project purchases but not be in a hurry to act.

What most companies fail to realize is how business relates to the financial markets. The saying goes that “only fools pick tops and bottoms.” The desire to over expand is due to the pressure of stakeholders within and outside the company. The amount of capital tied up in stakeholder equity forces the issues of expansion. There is little return in current “safe” investments, i.e. bonds, so the only option is to forge ahead and look for a high return on equity. What is the fastest way to grow sales, by new store expansion?

Dollar General should take the time to evaluate the current expansion picture of the company. A systematic approach to growth should be the only strategy. Short-term gains in rapid growth are only that, short-term. Dollar General should be more inclined to purchase real estate property and hold any new prime lots rather than building new structures on them immediately. The loss on the commercial property is going to be much less if the value continues to decline with no improvements versus a new store sitting upon the property. How much lower can real estate prices fall? It is hard to know but if they lose value at the current pace indefinitely there is little doubt that companies like Dollar General, or any other company, is going to survive anyway.

The short-term focus should be on remodeling along with the commercial real estate speculation. Store remodeling not only eliminates a portion of the upfront cash risk, it also appears favorable to customers in the community. One would find it difficult locating consumers who refuse to enter a remodeled store and only shop at newly constructed stores. This brings another benefit. Remodeling as it relates to the construction industry is often more profitable to contractors than new construction. What does hiring local contractors to remodel buildings in a community that needs it mean? It provides instant, supportive and loyal future customers.

A third specific course of action may be the possibility of Dollar General to further work with communities at a local level. Many communities, urban or rural, that Dollar General looks to move into have difficulty keeping neighborhood grocery stores. Dollar General should work with community leaders and show the benefit it offers to the community with the basic grocery selections in stores. If Dollar General wants to expand what it stocks in stores, the groceries should be that area. If possible there may even be vacant grocery stores, or stores nearing closing already in these communities that Dollar General could purchase and remodel. This would also aid in creating as much of a “win-win scenario” that is plausible for small communities and more loyal future customers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.