Dollar General: Weakness Continues As Consumers Remain Cash-Strapped

Jun. 5.13 | About: Dollar General (DG)

Shares of Dollar General (NYSE:DG) have seen a correction after the discount retailer reported its first quarter results of 2013 before the market open on Tuesday. Shares initially fell hard on the news, but managed to recover some lost ground in Wednesday's trading session despite the general market sell-off.

Ironically enough, the continued pressure on the US consumer which helped Dollar General in the recession and the years following is now turning against the company. Many US consumers are simply cash strapped and have little to spend at its stores.

First Quarter Results

Dollar General generated first quarter revenues of $4.23 billion, up 8.5% on the year before. Same store sales rose by 2.6% driven by both an increase in traffic and average spending. Revenues just missed consensus estimates of $4.24 billion.

Dollar General reported net income of $220 million, up just 3.3% on the year before. As a result of sizable share repurchases, earnings per share rose by four cents, or 6.3% to $0.67 per share.

Dollar General points out that adjusted earnings did increase by 8% to $232 million. Adjusted earnings exclude the costs related to the secondary offering of stock and the restructuring of its credit facility. Adjusted earnings came in at $0.71 per share, in line with analyst expectations.

Looking Into The Results

Dollar General is suffering from continued pressure on US consumers. Same store sales growth came off as a result of poor spring weather, tax refund delays and an increase in payroll taxes. This has resulted in an increase in consumables spending vs. non-consumable items.

Gross profits fell 90 basis points to 30.6% of total sales. Higher markdowns related to the weather and a shift toward consumables which carry lower margins and an increase in theft are to blame. The margin compression was partially made up for by increased efficiencies in transportation and moderating fuel prices.

Selling, general and administrative expenses saw some good effects from operating leverage. Expenses fell 37 basis points to 21.3% of total revenues on the back of lower incentive compensation and more efficient workforce scheduling.

All in all, adjusted operating profits fell by 60 basis points to 9.3% of total sales.

Valuation

Dollar General ended its first quarter with $155.5 million in cash and equivalents. The company operates with $2.84 billion in short and long term debt, for a net debt position of around $2.7 billion.

Dollar General generated full year revenues of $16.0 billion for 2012, up 8.2% on the year before. Net income advanced by 24.3% to $952.7 million.

Currently exchanging hands around $50 per share, the market values the firm around $16.4 billion. This values shares at essentially 1.0 times last year's revenues and 17-18 times annual earnings.

Dollar General currently does not pay a dividend.

Some Historical Perspective

Dollar General sold its shares to the public back in 2009 at $21 per share. The economic environment in the years following has been excellent for discount merchandise retailers as the lower and middle class of the US retail landscape continues to remain under pressure.

While initially the worsening economic circumstances boosted demand for Dollar General's products, the continued stagnation in real wages and increase in payroll taxes is now proving to be a drag. Shares peaked at $55 in the summer of last year and are currently exchanging hands around $50 per share.

Between 2009 and 2012, Dollar General has increased its annual revenues by a cumulative 36% to $16.0 billion. Net income almost tripled to $953 million in the meantime.

Investment Thesis

Ironically enough, the weak US economy which actually boosted the prospects for Dollar General in recent years, is now providing a drag on the business.

Dealing with the increase in payroll taxes and tax refund delays, many "customers" have opted to steal from Dollar General instead. The company admitted that theft is becoming a real issue, especially on higher priced items as the company takes measures to limit "inventory shrinkage."

Packaged foods and consumables continue to perform well, but these products and the addition of well-known national brands to boost appeal to a broader range of shoppers, combined with an increase in theft, have resulted in severe margin pressure. As the weather improved sales did recover a bit at the start of the current quarter, but they remain under expectations.

Consequently the company is cutting its full year guidance. Same store sales are expected to increase by 4-5% as the upper end of the range was cut by one percent point. Earnings are expected to come in between $3.15 and $3.22 per share, which implies that the upper end of the range has been lowered by eight cents. The outlook fell short of consensus estimates of $3.28 per share and implies that shares are valued at 15 times this year's earnings and 0.9 times annual revenues.

Shares of competitor Family Dollar (NYSE:FDO) have fallen 10% on the year as well after issuing two profit warnings. These dollar stores don't just suffer from a weaker external environment. Increased competition from Wal-Mart (NYSE:WMT) which is offering a broader range of items below $1 is hurting as well.

The company is a bit more hopeful for the remainder of the year, as comparables for the first quarter were particularly tough. The poor weather and increased payroll taxes combined made it difficult to show decent growth rates on a year-on-year basis. The company aims to open 635 new stores during the year, expanding the store base by 6%.

Back in September of 2012, I evaluated the prospects for Dollar General. I concluded that the valuation was becoming stretched as growth slowed down after a few very strong years. From that point in time shares have actually fallen a bit, completely missing out on the broad-based market rally which occurred ever since.

Today I reiterate my stance. The poor gross margin developments and limited flexibility on the balance sheet combined with a fairly high valuation limit the short to medium term upside potential in my opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.