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I remember watching BNN around the time of the recession and listening to the analysts say buy Discount stores. At the time, he talked about how people are now looking to save money and are seeking to find good prices for everyday items. He stated that discount stores were a way to capitalize on the market based on the needs of the time.

Five years later, I still believe these stores are a buy or at least should be on your radar. Due to the recession there has been a change in the way people spend. It could be that habits were formed during the recession, could be that there is an underlying thinking that we could go through that again, who knows but there has been a change in the way people are spending their money and it doesn't look like that is going to change anytime soon.

At the beginning of 2008, Dollar General Corporation (DG) defined four operating priorities that the company would focus on moving forward. The operating priorities would enhance to the philosophy of Save Time. Save Money. Everyday! These operating priorities are:

  1. Drive productive sales growth
  2. Increase our gross margins
  3. Leverage process improvements and information technology to reduce costs
  4. Strengthen and expand Dollar Generals culture of serving others.

This turned out to be a timely refocus for the company, as the combination of change within the company and a recession that would make people assess how they were going to save money created an environment that would set-up and drive discount stores such as Dollar General into the future.

Dollar General's management plan to drive productive sales growth was implemented by increasing shopper frequency and transaction amount by sales per square foot. The company planned to achieve this by offering the most productive merchandise offering to their customers. As Dollar General has direct buying relationships with companies such as Coca-Cola (KO) and Procter and Gamble (PG) and others, they have been able to analyze and compare products to get the most sales per square foot.

The next priority was to increase the gross margins. The company planned to do this by "the expansion of private brand offerings, increased foreign sourcing, shrink reduction, distribution and transportation efficiencies and improvements to our pricing and markdown model, while remaining committed to our everyday low price strategy."

The third priority of leverage process improvements and information technology to reduce costs is based on internal spending. Dollar General has focused on reducing internal costs such as Selling, general and administrative expenses (SG&A). The plan was to reduce internal costs that do not affect the customer experience.

The final priority was to strengthen and expand Dollar General's culture of serving others. The company's plan to achieve this was to enhance charitable initiatives and other efforts. According to Dollar General's annual report, In 2012, we, along with our vendors, customers and employees, donated millions of dollars.

Using the analysis below, I will analyze the past five years of Dollar General's performances. I will look at Dollar Generals past profitability, debt and capital, and operating efficiency. Based on this information, we will be able to see how the four operating priorities listed above have enhanced the company fundamentals.

All numbers sourced from Dollar Generals Website and Morningstar.

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets, and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2009 = $108 million
  • Net income 2010 = $339 million
  • Net income 2011 = $628 million.
  • Net income 2012 = $767 million.
  • Net income 2013 = $953 million.

Over the past five years Dollar General's net profits have increased from $108 million in 2009 to $953 million in 2013. This represents an increase of 782.41%. The company's ability to execute the plan to drive productive sales growth through offering the most productive merchandise to its customers has paid off.

  • Operating income 2009 = $580 million.
  • Operating income 2010 = $953 million.
  • Operating income 2011 = $1.274 billion.
  • Operating income 2012 = $1.491 billion.
  • Operating income 2013 = $1.655 billion.

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Like the net income Dollar General's operating income has also increased. Over the past five years, the company's operating income has increased from $580 million to $1.655 billion. This is a product of

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2009 = $108 million
    • Net income 2010 = $339 million
    • Net income 2011 = $628 million.
    • Net income 2012 = $767 million.
    • Net income 2013 = $953 million.
  • Total asset growth

    • Total assets 2009 = $8.889 billion.
    • Total assets 2010 = $8.864 billion
    • Total assets 2011 = $9.546 billion
    • Total assets 2012 = $9.689 billion.
    • Total assets 2013 = $10.368 billion.
  • ROA - Return on assets

    • Return on assets 2009 = 1.21%
    • Return on assets 2010 = 3.82%
    • Return on assets 2011 = 6.58%
    • Return on assets 2012 = 7.92%.
    • Return on assets 2013 = 9.19%.

Over the past five years, Dollar General's ROA has increased from 1.21% to 9.19%. in 2013. This indicates that the company is making more money on its assets than it did in 2009.

Quality Of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2009

  • Operating income 2009 = $580 million
  • Net income 2009 = $108 million

2010

  • Operating income 2010 = $953 million.
  • Net income 2010 = $339 million

2011

  • Operating income 2011 = $1.274 million.
  • Net income 2011 = $628 million.

2012

  • Operating income 2012 = $1.491 million.
  • Net income 2012 = $767 million.

2013

  • Operating income 2013 = $1.655 million.
  • Net income 2013 = $953 million.

Over the past five years, the operating income has been higher than the net income. This indicates that Dollar General is not artificially creating profits by accounting anomalies such as inflation of inventory.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2009 = $8.889 billion.
    • Total assets 2010 = $8.864 billion
    • Total assets 2011 = $9.546 billion
    • Total assets 2012 = $9.689 billion.
    • Total assets 2013 = $10.368 billion.
    • Equals and increase of $1.479 billion
  • Total liabilities

    • Total liabilities 2009 = $6.058 billion.
    • Total liabilities 2010 = $5.473 billion.
    • Total liabilities 2011 = $5.492 billion.
    • Total liabilities 2012 = $5.020 billion.
    • Total liabilities 2013 = $5.382 billion.
    • Equals an decrease of $676 million

Over the past five years, Dollar General has increased its total assets by $1.479 billion while they have decreased its total liabilities by $676 million.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2009 = $1.870 billion
    • Current assets 2010 = $1.845 billion
    • Current assets 2011 = $2.368 billion
    • Current assets 2012 = $2.275 billion
    • Current assets 2013 = $2.677 billion
  • Current liabilities

    • Current liabilities 2009 = $1.075 billion
    • Current liabilities 2010 = $1.207 billion
    • Current liabilities 2011 = $1.365 billion
    • Current liabilities 2012 = $1.510 billion
    • Current liabilities 2013 = $1.739 billion
  • Current ratio 2009 = 1.74
  • Current ratio 2010 = 1.53
  • Current ratio 2011 = 1.73
  • Current ratio 2012 = 1.51.
  • Current ratio 2013 = 1.54.

Over the past five years, Dollar General's current ratio has declined from 1.74 in 2009 to 1.54 in 2013. Even though the ratio has declined over the past five years the ratio is still above 1. As the ratio is above 1, this indicates that the company would be able to pay off its obligations if they came due at this point. This indicates financial strength.

Common Shares Outstanding

  • 2009 shares outstanding = 317.85 million.
  • 2010 shares outstanding = 340.59 million.
  • 2011 shares outstanding = 341.51 million.
  • 2012 shares outstanding = 338.09 million.
  • 2013 shares outstanding = 327.07 million.

Over the past five years, the number of company shares has increased. The amount of common shares has increased from 317.85 million in 2009 to 327.07 million in 2012. Even though the amount of shares has increased over the past five years, Dollar General has begun repurchasing its shares.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2009 = $3.061 million / $10.458 billion = 29.27%.
  • Gross margin 2010 = $3.690 million / $11.796 billion = 31.28%
  • Gross margin 2011 = $4.177 million / $13.035 billion = 32.04%
  • Gross margin 2012 = $4.698 million / $14.807 billion = 31.73%.
  • Gross margin 2013 = $5.085 million / $16.022 billion = 31.74%.

Over the past five years, Dollar General's gross margin has increased. The ratio has increased from 29.27% in 2009 to 31.74% in 2013. As the margin has increased, this indicates that Dollar General has been less efficient.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2009 = $10.458 billion.
    • Revenue 2010 = $11.796 billion.
    • Revenue 2011 = $13.035 billion.
    • Revenue 2012 = $14.807 billion.
    • Revenue 2013 = $16.022 billion
    • Equals an increase of 53.02%.
  • Total Asset growth

    • Total assets 2009 = $8.889 billion.
    • Total assets 2010 = $8.864 billion
    • Total assets 2011 = $9.546 billion
    • Total assets 2012 = $9.689 billion.
    • Total assets 2013 = $10.368 billion.
    • Equals and increase of 16.64%.

As the revenue growth has increased by 53.02% while the assets have increased by 16.64%, this indicates that the company has been generating more money from its assets than it did in 2009.

SG&A % Sales = SG&A / total sales

Reported on the income statement, it is the sum of all direct and indirect selling expenses, and all general and administrative expenses of a company.

High SG&A expenses can be a serious problem for almost any business. Examining this figure as a percentage of sales or net income compared with other companies in the same industry can provide insight as to whether management is spending efficiently or wasting valuable cash flow.

As part of the operating priorities, managements plan was to reduce costs regarding internal spending. Even though the company's SG&A expenses have increased the percentage compared to sales is down. This indicates that management is more efficient at administrative costs compared to there total sales.

  • 2009 - $2.481 billion / $10.458 billion = 23.72%
  • 2010 - $2.737 billion / $11.796 billion = 23.20%
  • 2011 - $2.902 billion / $13.035 billion = 22.26%
  • 2012 - $3.207 billion / $14.807 billion = 21.66%
  • 2013 - $3.430 billion / $16.022 billion = 21.41%

Based on the analysis above, Dollar General has shown very successful results regarding its focus operating priorities. Over the past five years, the company's revenues have increased, the company earnings have increased, the company's liabilities have decreased, the company SG&A ratio has decreased and over the past year Dollar General has repurchased shares. The only weakness regarding managements plan is in the working capital. This indicates that the company does not have as much liquidity as it did five years ago. As the ratio is still above 1 this does not raise any "red flags". Overall Dollar General has shown success regarding managements operating priorities.

Future Headwinds

Currently, there are some strong indicators that are projecting a short-term correction regarding its stock price. Over the past three years the stock price has had an nice run-up. Technically speaking the stock is currently at a point of resistance. This could prove to be where the stock price begins to fall. Another indicator for some short-term selling is, over the past year there has been a large amount of insider selling. As recently as 22/04/2013 Director Adrian Jones sold 975,177 shares valued at $48,895,374 and on 03/04/2013 he sold 6,391,602 valued at $320,474,924. It is always a concern when the board director sells just over 7 million shares in one month. These factors lead me to believe that there should be some short-term selling in the near future. But, as we get closer to Q4, which it typically the strongest quarter for Dollar General, I think the selling will subside and the upward trend will continue.

Analysts at MSN Money are estimating significant growth for Dollar General over the next couple of years. For FY2014 analysts are estimating Dollar Generals EPS to be $3.29 while estimates for FY 2015 increase to $3.77 per share. Bloomberg Businessweek supports this idea as they expect revenues to be approximately $17.6 billion for FY 2014 and increase to $19.3 billion for FY 2015.

Based on the analysis above we can conclude that Dollar General has been very successful in capitalizing on a market that needed its products. Management's plan to implement its four operating priorities that reduce internal costs without diminishing the customer experience, has proved to be very successful for the company. In the short-term there could be some turbulence in the stock price but if patience is exercised there could be an opportunity later in the year to invest in a solid company with a positive growth outlook based on the customers spending needs and habits.

Source: Dollar General: Spending Habits Will Keep Driving This Stock