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Stock Analyst Update

Dollar General Bucks Retail Trends, but Shares Pricey

Despite strong results at the narrow-moat retailer, a continued increase in fresh food and frozen coolers will constrain profitability.

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Narrow-moat  Dollar General's (DG) third-quarter results support its intangible assets and cost advantages, as the firm drove strong 4.3% comparable-store growth (both traffic and ticket were positive) and modest gross margin expansion (8 basis points to 29.9%), despite the competitive landscape. These results and time value of money warrant us to increase our $80 fair value estimate by a mid-single-digit percentage, but we now recommend investors wait for a better margin of safety. While we plan to review our long-term assumptions of 6.1% top-line growth, driven by 2.1% comparable-store sales, and average operating margins of 8.7%, we don’t plan to make any material changes.

There’s no surprise that Dollar General has bucked retailing trends thus far by continuing to drive traffic with only modest margin pressures along the way. That said, we see profitability constrained, driven by the company’s continued increase in fresh food and frozen coolers (will average 18 doors per store in 2018 up from 10 in 2012), and due to "Better For You Isles (healthier food, less salt, etc.)," which was discussed this quarter. These initiatives should continue to drive traffic but increase the complexity and cost of stores, a key rationale for our relatively flat operating margins assumption over the next decade. We believe this was evident this quarter, as the firm was not able to leverage selling, general, and administrative costs, as it increased to 22.9% from 22.5% last year, despite the strong traffic in stores. We acknowledge the firm increased its wage and incentive compensation for its employees (beneficial to its long-term competitive advantage), but still see the firm operating close to peak margins. 

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John Brick, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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