Will Dollar General (DG) drop the mic once again?
The retailer is a few days away from reporting the results of its second quarter. Last time, the company delivered one of the most impressive set of results that I have ever seen in the retail space, ex-Amazon (AMZN). Yet, since then, the stock has underperformed the S&P 500 (SPY) by about seven percentage points and the retail sector (XRT) in general by an even wider margin.
Analysts expect revenues to increase at a pace of 19.5% which, if achieved, would represent deceleration from last quarter’s growth levels. EPS is projected to land at $2.44, benefitting from gains of scale but also growing at a slower rate than it did in the first period of 2020.
What to expect
Starting from the top, it is hard to imagine Dollar General struggling to generate sales traction in the current environment. At a high level, the retailer has been benefiting from a number of factors that include (1) the “stockpiling blitz” of non-perishable household items, (2) government support in the form of direct payments and increased unemployment benefits, (3) heavier revenue mix of consumable products compared to seasonal and apparel, (4) unwavering pace of new store openings, and (5) market dominance in rural areas, where the retailer has an enviable footprint.
More specifically on the second quarter, big box retailers like Walmart (WMT) have already shown evidence that demand continues to be robust, with e-commerce strength and large ticket size helping to offset some decline in foot traffic and transaction volume. Peers like Target (TGT) and Costco (COST) have done an even better job in the past few months. See graph below, in which I place Dollar General’s and Walmart US’s historical comps side by side.
Source: DM Martins Research, using data from multiple reports
One key potential headwind to revenues is the impasse on fiscal stimulus at the end of July. With the economy still far from being back on its feet, government support has been crucial to maintain consumer spending at healthy levels. While I could see some drag to revenues caused by the drop off in additional unemployment benefits, I find it unlikely that this factor alone will be a meaningful force offsetting what I expect to be overwhelmingly positive top-line developments.
Further down the P&L, I believe margins will be influenced (lifted, in this case) primarily by gains of scale, as was the case last quarter – i.e., higher expenses, but even higher revenues. I see the potential of some loss of profitability from increased personnel costs due to the COVID-19 crisis, although I think that these challenges will go largely unnoticed in the grand scheme of things.
On the stock
Despite having delivered outstanding results recently, Dollar General has not seen its stock rise much since it reached $180 apiece in mid-April – shares are still worth less than $200 today. This could either mean that DG (1) has rushed too fast to all-time highs and needed to catch its breath or (2) is underappreciated by the markets and deserve to climb from current levels. A look at where P/E stands now vs. prior to the crisis (see graph below) suggests that the first hypothesis has its merits.
But I choose to look at DG as a long-term, buy-and-hold type of investment. From this perspective, I appreciate Dollar General’s track record of producing strong financial results through economic prosperity and hardship. This has been the case due to a combination of good management practices and the company’s cycle-agnostic business model.
For this reason, I believe that this stock is a good investment for virtually any macroeconomic environment, which makes it one of my favorite (and among the most profitable) positions that I have held in my All-Equities SRG portfolio.
Beating the market by a mile
DG is one piece of my All-Equities Storm-Resistant Growth portfolio. Other mega-cap names have produced an even larger portion of the gains, which have been better than the S&P 500 by a mile (see graph below, pink line).
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Disclosure: I am/we are long AMZN, COST, DG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.