Rick Dreiling, who has been at the helm of dollar-store retailer Dollar General (DG) for the past six years, recently called it quits. Dreiling will retire in May 2015 or when a successor is named — whichever comes first — and while he has offered to maintain his chairmanship during the transition, a Dreiling-led DG is essentially history.
But perhaps more immediately, it threatens to diffuse speculation that Dollar General could acquire smaller peer Family Dollar (FDO)
Family Dollar’s shares are roughly flat year-to date, and the company recently reined in expansion goals amid a drop in sales. Theories surrounding a DG/FDO combination grew wild amid activist investor Carl Icahn’s calls for the latter company to be sold.
But now, amid Dreiling’s departure, what should investors expect?
Dollar General’s fundamentals during Rick Dreiling’s tenure haven’t been too shabby. As the company notes in its press release:
“Under his leadership, the [c]ompany’s annual sales have increased more than 80 percent to $17.5 billion in 2013 and store count has increased by 38 percent to more than 11,000 stores in 40 states.”
Net income has grown over the period, too.
But same-store sales growth has dropped off since Dreiling took the helm; Dollar General has gone from generating same-store sales growth of 9.5% in 2009 to a 3.3% increase last year.
In a report, BB&T Capital Markets analyst Anthony C. Chukumba pointed to Dollar General’s impressive run since a 2009 IPO, with shares rising an impressive 175% vs. the S&P 500 Index’s 80% gain. But for the shorter term, it has been a different picture. DG stock over the past year has failed to keep pace with the S&P 500, with shares up 15%, but underperforming the index by about 8 percentage points.
And one can argue that shareholder value has been eroded as the company has adopted an “increase in long-term obligations incurred to repurchase shares under [the] share repurchase program,” of which it has $223 million remaining. Although DG’s debt-to-equity ratio of about 0.5 is lower than that of several of its peers, a declining profit margin is worrisome.
Considering the tepid economic recovery that the U.S. is experiencing — evidenced by the recent downward revision to first-quarter GDP — DG stock should be thriving as low-income consumers turn to small-box retailers for their items.
The fact that DG stock is not flourishing points to one thing — a potentially flawed strategy championed by Dreiling.
Indeed, Dollar General thus far has deliberately favored expanding its footprint organically vs. growing by acquisition, with plans to open some 700 new locations this year alone. Meanwhile, competitors Walmart (WMT) and Target (TGT) started gunning for the dollar stores’ territory with their smaller-store formats, fueling a highly promotional environment that has cramped margins for Dollar General, as sales from consumables, which carry the lowest margins, have been outpacing those of its higher-margin segments.
The scenario has been worse for Family Dollar, which instead of expanding its footprint has been closing stores, followed by Icahn taking his stake in the company and making a call for change. In a filing with the U.S. Securities and Exchange Commission, Icahn stated: “It is imperative that Family Dollar be put for sale immediately.”
It has been widely speculated that Dollar General would be a likely buyer of its smaller rival, given the obvious opportunity to take market share in the regions where it lacks a presence.
But now, with the transitional period that Dollar General is about to undergo coupled with Family Dollar’s own recent defection of president and chief operating officer Michael Bloom, that scenario has lost steam. Chukumba, who has a “hold” rating on DG stock, said in the report:
“We think it is very unlikely Dreiling’s eventual successor would be inclined to immediately risk his or her legacy by making a very large and transformative acquisition early in their tenure.”
Fundamental growth with the sting of a declining share price? That’s probably not the legacy Dreiling set out to achieve. Nonetheless, it’s one that he is faced with.
The future direction of Dollar General hangs in the balance, and while the chief’s departure certainly weakens the case for a DG/FDO combination, a deal could theoretically still be in the cards — if another suitor doesn’t act first.
But with Walmart and Target expanding their respective small-store format presence and stealing market share, and with DG’s lack of a particular catalyst for growth despite fertile economic ground for discount retailers, you might want to hold off on the dollar stores for now until there is a clearer road ahead.
As of this writing, Gerelyn Terzo did not hold a position in any of the aforementioned securities.