Dollar General: While Headwinds Could Pressure Profits, We Still See Value in the Shares

We’ve lowered our fair value estimate for narrow-moat Dollar General DG to $140 per share from $179 due to a significant pullback in our profitability expectations for the next several years and a more subdued midcycle operating margin forecast of 8.2% (from 9.0%). However, we still think the stock, trading at around a 15% discount to our intrinsic valuation, offers an attractive risk/reward.

With Dollar General’s core customer earning close to $40,000 per year and often relying on federal assistance, we expect the abatement of pandemic-induced fiscal stimulus to weigh on the top line—we forecast a low-single-digit decline in same-store sales in fiscal 2023 and 2024—and pressure margins from sales deleverage (a deviation from the more than 35% and 40% respective gains in sales and operating profits the past three years). Furthermore, Dollar General’s store base appears to be stretched thin, and recent investments to improve staffing levels and rectify concerns about working conditions are likely to weigh on the bottom line. Given the combination of sluggish growth and necessary investments at the store level, we forecast operating margins of 6.0%-7.0% over the next several years, a stark contrast to Dollar General’s 9.6% average margin during 2020-22.

However, we still believe Dollar General enjoys a competitive edge, and we view its low-cost and convenience-driven value proposition as largely intact. The firm’s more than 19,000 small-box locations are positioned in thinly populated towns where competition is minimal, allowing the stores to serve as a convenient fill-in shopping destination for rural communities that lack an abundance of shopping alternatives. Furthermore, Dollar General’s impressive store density prompts a cost advantage, in our view, as the firm can leverage its product delivery routes to fulfill the merchandising needs of numerous nearby locations—an element we view as vital when operating in rural areas.