Don’t Panic, This Stock Is Still Solid

Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The king of dollar stores had to bow down before the fiscal cliff. Dollar General (NYSE: DG), which I believe is one of the best ways to play the patchy economic conditions, fell almost 8% after the company issued a cautious outlook for the current fiscal year. Management stated that they are bracing for the fiscal cliff by introducing more competitive pricing and spending more on advertisements, in order to stand toe-to-toe with other dollar stores and retailers such as Wal-Mart (NYSE: WMT).

This led the company to reduce its fiscal 2012 earnings guidance, and it now expects to earn between $2.82 and $2.85 this year while analysts called for $2.86. This masked the positivity of the company’s third-quarter results which were, once again, fantastic. Revenue in the quarter jumped north by 10.3% on the back of a 4% improvement in same-store sales. More importantly, the company witnessed a jump in traffic along with an improvement in the average ticket size for the 19th consecutive quarter.

Punished for Sharing the Customer’s Pain

However, the Street laid more stress on the outlook and Dollar General shares witnessed their biggest decline in the past 18 months. CEO Rick Dreiling used strong words for issuing the cautious outlook, telling JPMorgan Chase & Co. analyst Matt Boss that he believes that the customer is under a lot of pressure due to the impending fiscal cliff. As the payroll tax cuts expire, customers’ purchasing power is slated to take a hit, and this in turn might have forced Dollar General to slash pricing in order to keep items affordable and also keep customer traffic intact.

However, I still believe that Dollar General is the boss of discount retail stores and it doesn’t deserve to be bashed so much for being cautious. The impending fiscal cliff might reduce the purchasing power of customers and Dollar General is preparing itself for the worse and the transition might be a bit painful. For example, Wal-Mart is already providing tough competition to dollar stores by undercutting their pricing, focusing on selling more $1 or less priced items and advertising the same.

Growth Written All Around

Hence, Dollar General’s move to get more competitive is not exactly a shot in the foot as this will enable it to keep customers flowing into its stores. Also, Dollar General has above 10,000 stores, which is more than what both Family Dollar Stores and Dollar Tree (NASDAQ: DLTR) have, and it is still expanding aggressively. A big store count leads to diversification, and expansion will lead to more coverage.

Also, the company is winning market share in consumables and as this is a healthy sign as consumers will look to save the most on consumable items as we approach the cliff and even beyond. Moreover, Dollar General upped the lower end of its same-store sale forecast for the year to 4.5-5%, up from the previous expectation of 4-5%. The company has been consistently recording decent same-store sale growth and its updated expectation shows that efforts to bring in more customers are bearing fruit.

So it is no surprise that Dollar General has consistently outperformed other dollar stores in terms of customer traffic. For example, Dollar Tree, which posted its third-quarter results last month, witnessed a meager 1.6% growth in same-store sales. However, even Dollar Tree is looking to improve over the long-term by way of an aggressive store expansion program and its offering of $1 products should help it benefit from constrained spending. Furthermore, a lower price should enable Dollar General record a bigger average ticket size as consumers would try to stretch their dollars as much as possible.

Interestingly Valued

Also, Dollar General is nicely valued when stacked up against peers. The stock trades at a trailing P/E of 16.38, which is lower than the industry average of 21.59 and is competitive when we consider Dollar Tree’s P/E ratio of 15.60 and Family Dollar’s 18.41. In addition, Dollar General is expected to grow faster than the others with a PEG ratio of 0.89, lower than even Wal-Mart’s ratio of 1.52.

The Takeaway

A cut-down in sales and earnings forecast might be a cause for concern. But over the long term, Dollar General still seems like a strong bet. A wide network of stores coupled with low prices and consistently improving earnings and sales is a potent combination that shouldn’t be ignored by investors. One needs to see beyond the current negativity around the stock and keep their faith in this dollar giant, which has consistently delivered returns in the past and still seems good to deliver more.

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