Dollar General Stock: 3 Pros, 3 Cons

by Tom Taulli | March 22, 2012 1:07 pm

DollarGeneral Dollar General Stock: 3 Pros, 3 Cons[1]Dollar General (NYSE:DG[2]) posted yet another strong quarter Thursday morning. Sales increased by 20% from the year-ago period to $4.19 billion, and profits were up a whopping 34% to $292.5 million, or 85 cents per share. Adjusted earnings of 86 cents beat the Street consensus for 82 cents.

Dollar General’s stock was up about 3.7% to $46.40 on the news, continuing DG shares’ run-up of around 50% for the past 52 weeks.

So, can the discount retailer keep up its red-hot momentum? Let’s look at the pros and cons of Dollar General:

Pros

Strong Platform: Dollar General has almost 10,000 stores in 38 states. The company sells top brands — including products from Kraft Foods (NYSE:KFT[3]) and Kellogg (NYSE:K[4]) — at steep discounts. By focusing on consumables like salty snacks and carbonated beverages, Dollar General gets lots of ongoing traffic to its stores.

Growth: Dollar General certainly has much more room to expand. For the most part, its footprint is in the south western states. This year, the company plans to add about 625 stores, which will be in new markets like California, Nevada, Connecticut, Massachusetts and New Hampshire.

Momentum: In its earnings report, Dollar General expects revenue growth of 10% to 11% for fiscal 2012, and it also said its earnings per share would range from $2.65 to $2.75 — higher than previous forecasts and around analysts’ expectations for the company to earn $2.71 per share. Best of all, the company usually is conservative with its estimates — in other words, there is likely to be even more growth ahead for DG.

Cons

Margins: This always is a tough metric for deep discounters like Dollar General, but 2012 could be even more challenging than usual. The company continues to expand into new markets — which will mean adding new distribution centers — and DG also is making heavy investments in new technologies. While these efforts will have long-term benefits, they will put pressure on gross margins for the current year.

Competition: The environment is intense. There are tough rivals like Family Dollar (NYSE:FDO[5]), Dollar Tree (NASDAQ:DLTR[6]) and 99 Cents Only. And the retail giants, like Wal-Mart (NYSE:WMT[7]) and Target (NYSE:TGT[8]), also are stepping up efforts to keep prices low.

Valuation: Dollar General stock is far from cheap, trading around 23 times earnings.

Verdict

Dollar General has been a big beneficiary of the economic downturn. Basically, many cash-strapped consumers have traded down to lower-priced offerings.

But could the recent uptick in the U.S. economy dampen this trend? It’s possible, but it seems unlikely. Even if unemployment continues to get better, the newly created jobs won’t necessarily be high-paying, which means consumers likely will continue focusing on discounts.

In light of Dollar General’s strong platform and growth opportunities, the prospects still look bright. And while the valuation is not cheap, the fact is growth usually comes at a premium.

And as an added bonus, DG has Warren Buffett’s vote of confidence, with Berkshire Hathaway (NYSE:BRK.A[9], BRK.B[10]) holding shares in the company[11].

All in all, the pros outweigh the cons on Dollar General for now.

Tom Taulli runs the InvestorPlace blog IPO Playbook[12], a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”[13]“All About Short Selling”[14] and “All About Commodities.”[15] Follow him on Twitter at @ttaulli[16] or reach him via email[17]. As of this writing, he did not own a position in any of the aforementioned securities.

Endnotes:
  1. [Image]: http://investorplace.com/wp-content/uploads/2012/03/DollarGeneral.png
  2. DG: http://studio-5.financialcontent.com/investplace/quote?Symbol=DG
  3. KFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=KFT
  4. K: http://studio-5.financialcontent.com/investplace/quote?Symbol=K
  5. FDO: http://studio-5.financialcontent.com/investplace/quote?Symbol=FDO
  6. DLTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=DLTR
  7. WMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMT
  8. TGT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TGT
  9. BRK.A: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.A
  10. BRK.B: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.B
  11. holding shares in the company: http://investorplace.com/2011/08/stock-picks-billionaire-investors-msft-dg-ep-ge/
  12. IPO Playbook: http://investorplace.com/ipo-playbook/
  13. “The Complete M&A Handbook”: http://goo.gl/aLNDk
  14. “All About Short Selling”: http://www.amazon.com/All-About-Short-Selling/dp/0071759344/ref=sr_1_1?s=books&ie=UTF8&qid=1302184310&sr=1-1
  15. “All About Commodities.”: http://www.amazon.com/All-About-Commodities/dp/0071769986/ref=ntt_at_ep_dpi_10
  16. @ttaulli: https://twitter.com/ttaulli
  17. email: mailto:tom@taulli.com

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