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Shares of this discount retailer look pricey compared with peers, and customers may trade up as the economy recovers.
Tags:The Position of Dollar General,business tips,dollar general position,dollar general stock,economy recovery,morningstar,options tips,retail sector,consumer services
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The Position of Dollar General
Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, co-editor of Morningstar Option Investor, and today it's my great pleasure to invite Zoe Tan, an analyst covering the retail sector, to talk about our position in Dollar General. Zoe, thanks for coming.
Zoe Tan: Thanks for having me.
Erik Kobayashi-Solomon: Zoe, a couple weeks ago I wrote an in-depth piece about Dollar General taking a bearish position in it, and really just wanted to get some more color on this company.
One of the first things that I wonder about, a few years ago, Dollar General really came into problems because they overbuilt, they oversaturated their markets, and they were taken private by KKR.
Now, they've IPO'd, and it seems like they're building a lot of stores again, they're back up talking about 500 new stores this year. Are they in danger of oversaturating again?
Zoe Tan: That certainly is a concern given that they have more than 8,000 stores already and the fact that they have been closing stores, almost 600 stores over the past few years. We do think that that is a sign that they are oversaturated.
Erik Kobayashi-Solomon: And that 500 a year is kind of unsustainable, right?
Zoe Tan: So, but in fact, they are actually going to a different concept that carries more grocery stores.
Erik Kobayashi-Solomon: These are the market niche stores, right?
Zoe Tan: Yes, that they are trying to roll out. However, we do think that is also a concern as they start to compete head to head with grocery stores, which have greater scale advantages, because they have greater purchasing volume that Dollar General may not be able to match.
Erik Kobayashi-Solomon: Right, I see. You know, this actually leads into another question. We've paired this investment with a bullish investment in Wal-Mart, and when I was reading about Wal-Mart, I realized that they were really shifting.
I mean, about half their sales now are from consumables, from grocery store kind of things, basically. So how does the presence of this giant, this Wal-Mart, selling to the same kinds of clients as Dollar General, how does this affect Dollar General?
Zoe Tan: I think given that they have the same consumer... same target group, they do exist in the same markets and they do compete to a certain extent. However, given that Dollar General is a smaller box store format, they are able to go into markets where Wal-Mart may not be able to go into.
Erik Kobayashi-Solomon: Just demographically, the demographics just don't support one of these enormous Wal-Mart stores.
Zoe Tan: Exactly.
Erik Kobayashi-Solomon: I see. So, there's some competition, but it's not head to head, let's say?
Zoe Tan: Yeah, I would think so.
Erik Kobayashi-Solomon: Now, one other thing. I just mentioned about KKR, this private equity group that took them private a couple years ago and then just IPO'd them recently, KKR still owns a pretty significant slug of shares.
My thought is, is that this slug of shares that they own actually might be bearish to the stock price, that, as they decide to unload more of these, the stock price will be put under pressure. I just wondered about your take on that and the valuation.
Zoe Tan: I certainly do see where you're coming from, I do agree that, KKR having a large stake, and if they start to offload some of it that might put some downward pressure on the stock, but on the other hand, their significant stake also puts their interests in line with that of shareholders.
Erik Kobayashi-Solomon: That's true.
Zoe Tan: But where I'm coming from is from, more from a valuation perspective. I do think that Dollar General, which is currently trading at 22 times earnings compared to its peers like Dollar Tree and Family Dollar, which are trading only at 14 and 15 times.
It certainly is overpriced, and the current stock price does kind of assume that current levels of productivity and profitability will extend into the long-term, but that's something that we don't think would continue, especially as the economy recovers, consumers might start to trade up to different channels.
Erik Kobayashi-Solomon: This is one thing that I noticed when I was looking through the models, that they will have a few years of really great results, but it doesn't last forever. I mean, it seems that they consistently stumble every couple of years.
Zoe Tan: That's certainly true, we do think that they are currently at a peak cycle, and we do see that coming down, especially as they start to lap two years of very good numbers. We do think that in the near-term it would be a catalyst to have the stock come down slightly.
Erik Kobayashi-Solomon: So, as the comparables become harder, they're comparing to some really strong years, people are going to realize, oh, wait a second, this can't last forever. Well, that's really interesting. Thanks a lot for coming, Zoe.
Zoe Tan: Thanks, Erik.
Erik Kobayashi-Solomon: And thank you for joining us. Please stop by the Morningstar Option Investor website where we have many more option investing ideas.