Recession Proof Stock with Strong Upside Potential
Sandeep is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Dollar stores have flourished during the recession and analysts have projected another year of good holiday sales. Dollar chains are good defensive picks with a high consumable mix. In an economic slowdown, discretionary income decreases and thus, a high consumable mix provides much needed stability. Thus, dollar stores exhibit “Recession Proof” characteristics and will continue to provide good returns even if the economy falls. Among the major dollar stores, Dollar General (NYSE: DG) has the highest consumables mix. Dollar General’s ~73% consumables mix is slightly better than Family Dollar’s (NYSE: FDO) ~67%, and well above Dollar Tree’s (NASDAQ: DLTR) ~51%.
Over the last few years, Dollar General has been consistetly driving market share gains. Dollar General’s Q2 results showed a 47% year over year growth in earnings and the company’s 2Q12 adjusted EPS of $0.69 was well above the consensus estimates of $0.64. On the sales front, the company did really well, posting 10.4% year over year growth, and both customer traffic and average the ticket increased for the 18th consecutive quarter. The management indicated that the early warm weather might have pulled some Q2 sales into Q1. That said Q2 SSS growth of 5.1% is still impressive and better than Dollar Tree’s reported SSS growth of 4.5%. Dollar General’s year to date SSS growth of 5.9% also stands above Dollar Tree’s 5.1%.
According to Yahoo! finance, Dollar General has an annual growth rate of 17.76% for the next five years which is higher than both Family Dollar and Dollar Tree. Despite having a higher consumable mix and better growth rate, Dollar General is trading at a discount to both Family Dollar and Dollar Tree. I think the market is overlooking the company’s strong growth profile and expect the multiple to expand. I anticipate an upside to the stock due to the following reasons.
3Q off to a Good Start and Promising FY12 Outlook
Encouragingly, back-to-school sales were up in the high-single digits with a noted improvement in more discretionary items, such backpacks and accessories. Thus far, management is pleased with the quarter to date sales trend and I expect the momentum to carry forward into the rest of the third quarter. I continue to see Dollar General taking share from traditional drug stores, grocery chains, and mass market retailers. Reflecting results to-date and lower financing costs, management has raised 2012 EPS guidance to $2.77-$2.85 (based on 4%-5% SSS growth) vs. the prior guidance of $2.68-$2.78 (based on 3%-5% SSS growth).
Multiple Initiatives Will Drive Sales Growth
Dollar General operates within an $830 billion market, largely against discounters such as Wal-Mart, and grocery and drug chains. The company’s consistent focus on value and convenience has led to average annual growth of 10% versus a market average of only 0.4%. Going forward, I believe multiple initiatives like the roll-out of beer and wine, increasing $1 items, higher penetration of private label & proprietary brand items and expansion of perishables will increase average basket size and overall sales productivity.
Gross Margin Improvement in 2H
Although, the company’s shift towards lower-margin consumables and potentially higher diesel prices will create some margin pressures, but I expect gross margins to improve in the second half due to improvements in distribution costs and smaller LIFO (“last in, first out”) charges. Moreover, the inflation environment appears relatively gentle at the moment, which reduces the likelihood of having to take margin hits on vendor price increases.
Thus, Dollar General appears to be well positioned to drive strong results in the coming quarters given the promising 2012 outlook, multiple initiatives to increase average basket size and improvements in distribution costs. The low consumable mix adds a further dimension to the company’s stability and makes it a “Recession Proof” stock. Thus, I recommend buying it.
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