This Week's IPO Calendar Features Two Discount Retailers: Dollar General and rue21

Includes: DG, RUE, STRI, VSI
by: Renaissance Capital IPO Research

With two traditional value retailers on the US IPO calendar for the week of November 9, we are offering a 2-for-1 deal for our featured IPO of the week. Dollar General (NYSE:DG), the country's largest discount retailer by store count, sells consumable goods and household items at over 8,700 stores in 35 states, while teen-oriented apparel retailer rue21 (NASDAQ:RUE) has 527 stores in 43 states and is growing its store base by nearly 100 locations per year. Both companies hope to emulate the success of Vitamin Shoppe (NYSE:VSI), which in late October became the first traditional retailer to go public in almost two years. Its stock is up 14%, and both Dollar General and rue21 will hope that their strong same-store sales growth and expansion opportunities whet investors' appetites. Both stocks are expected to price on Thursday; Dollar General's $750 million IPO is being underwritten by its private equity owners Citi, Goldman Sachs and KKR, while BofA Merrill Lynch, Goldman and J.P. Morgan are the bookrunners for rue21's $115 million offering.

Dollar General

Dollar General is a well-established discount retailer that sells consumables such as paper/cleaning products, food and health/beauty products, as well as kitchen supplies, apparel and seasonal products. The company's 8,700 small-box (7,000 square feet) stores, mostly located in the south, southwest and midwest regions, generate over $10 billion in annual revenue. The firm has impressively achieved positive same-store sales growth for 20 straight years. In mid-2007, it was acquired by a private equity consortium led by KKR, Goldman Sachs and Citigroup, who brought in a new management team that redesigned the stores, closed or relocated underperforming stores, improved private label brands and implemented cost-cutting initiatives. All of these have helped the company boost sales growth and margins; same-store sales growth accelerated from 2% in 2007 to 9% in 2008 and 11% year-to-date, while operating margin has improved from 4% to 8%. Going forward, Dollar General believes it can expand its store base by 5% annually while continuing to improve its products and supply chain management.


While Dollar General's consumer staple products make it a relatively defensive retail concept, rue21 is being positioned as a classic growth story. The company operates 527 stores that sell trend-focused value-priced apparel targeted at the 11-17 demographic. Its stores, which average about 4,500 square feet, are located in strip malls, regional malls and outlet centers, primarily in underserved small and middle markets. After emerging from bankruptcy in 2002 with a new management team, the firm has doubled its store base in the last three years and has averaged 8% same-store sales growth over the last five quarters. With its focus on teens and social networking-driven marketing campaigns, the company believes it can translate its strength in this demographic to 16-18% annual square footage growth and 2-4% same-store sales growth while increasing gross margins through product mix and scale.


Given the recession that has gripped the US over the last two years, it is unsurprising that these prospective retail IPOs are less exposed to economic weakness than the broader sector. Both Dollar General and rue21 offer relatively low price points for their goods and are therefore benefiting from tradedowns, which has helped them generate strong same-store sales growth. Most of Dollar General's products are priced below $10 and 25% are less than $1, and the company believes its products are generally cheaper than those at supermarkets or drugstores and at comparable prices to large-box retailers like Wal-Mart. Most of rue21's apparel is priced under $40, and it sells fragrances, many accessories and some apparel for under $10. While this price positioning has helped both companies grow same-store sales over the last two years, investors will be wary of the risk that consumers trade back up to higher-priced stores as the economy improves.

Other risks

Competition is one of the key risks for both of these companies. Dollar General competes with behemoths like Wal-Mart, Target and Costco as well as other discount retailers, supermarkets and drugstores. rue21 also faces the big-box value retailers and also competes against department stores, national off-price chains and other mall-based stores. Other potential risks for Dollar General include its large debt burden, possible failure of its attempts to revitalize its private-label products and the likelihood that same-store sales growth will fall once the current wave of remodelings and relocations is completed. rue21's other key risks are its exposure to discretionary consumer spending, retail center traffic and fashion trends.

Valuation concerns

Although the last 15 US IPOs have averaged a meager 3% first-day return in an increasingly price-sensitive market, continued deal flow momentum and STR Holdings' (NYSE:STRI) impressive debut last Friday (+31%) suggest that there is still strong demand for IPOs that are priced right. In that vein, both Dollar General and rue21 face the challenge of convincing investors that superior recent growth will continue. While double-digit unemployment and muted consumer sentiment should drive interest in these value-focused retailers, with both companies coming to market at 10.3x LTM EBITDA vs. peer averages in the 7-8x range, investors may not see their valuations as bargains unless they buy into the companies' outlooks for above-average sales and earnings growth.