Dollar General: Tobacco And Economic Struggles Continue To Drive Improvements

| About: Dollar General (DG)

Investors in Dollar General (DG) continue their winning streak with shares setting fresh highs at the moment. A solid set of third quarter results and analysts upgrades following the release are the drivers behind strong momentum in recent days.

On the back of these solid results, the continued economic struggles for large parts of society and the sale of tobacco products have pushed shares up some 35% this year.

This makes shares a bit too expensive to my taste, and despite the strong performance, I am comfortable staying on the sidelines.

Third Quarter Results

Dollar General generated third quarter revenues of $4.38 billion, up 10.5% on the year before.

Net earnings rose by 14% to $237 million. Earnings per diluted share were up by 19% to $0.74 per share, outpacing general earnings growth on the back of share repurchases.

Non-GAAP earnings came in two cents lower on the back of a $6 million benefit on the reversal of income taxes. Analysts were looking for adjusted earnings of $0.70 per share.

Looking Into The Results...

Dollar General's sales growth has been driven by a 4.4% increase in same-store sales, both on the back of an increase in traffic as well as average value being spent. The remainder of growth has been the result of store openings.

Gross earnings fell by 60 basis points to 30.3% of total sales. This is entirely due to sales mix effects with greater sales growth of consumables, including tobacco products which carry lower margins. On top of that, Dollar General suffered from more theft and higher markdowns.

Gross margin pressure was partially offset by operating sales leverage. Selling, general and administrative costs fell by 40 basis points to 21.8% of total sales.

On the back of lower tax rates and interest expenses, earnings did see solid growth, outpacing revenue growth.

...And Looking Ahead

On the back of the results, Dollar General now sees full year earnings of $3.18 to $3.22 per share. These earnings are achieved on expected net sales growth of 10% to 10.5%. Consensus estimates for earnings stood at $3.22 per share.

For 2014, Dollar General has not released official guidance yet. The company aims to open 700 new stores, while remodeling or relocating some 525 stores, growing the total square footage by 6% to 7%.


Dollar General ended the third quarter with $165.7 million in cash and equivalents. Total debt stands at $2.92 billion, resulting in a net debt position of $2.75 billion.

Revenues for the first nine months of this year came in at $13.01 billion, up 10.1% on the year before. Earnings rose by 10.7% to $702.9 million. At this pace, annual revenues are seen around $17.6 billion as earnings could come just above the billion mark.

Trading around $61 per share the market values Dollar General at $19.6 billion. This values equity in the firm at 1.1 times annual revenues and 19 times annual earnings.

Dollar General does not pay a dividend at the moment.

Some Historical Perspective

Dollar General went public back in November of 2009 when shares were sold to the general public at $21 per share. Ever since, shares have gradually moved upwards, currently trading around all time highs of $61 per share.

Between fiscal year 2009 and 2013, Dollar General was set to increase its annual revenues by a cumulative 50% to $17.6 billion. Net earnings are set to triple to just above the $1 billion mark.

Investment Thesis

The solid results prompted analysts at Goldman Sachs (NYSE:GS) to upgrade the rating on the discount retailer all the way from "Neutral" to "Conviction Buy." Analyst Grambling says that continued growth and share buybacks continue to propel the shares higher going forward.

Back in September of this year, I last took a look at the company's prospects. I concluded that while the company sells discounted merchandise, the strong performance results warrants a premium valuation. The outlook for discount stores remains solid despite the economic recovery as the lower and middle-class of society continues to struggle.

The introduction of tobacco products has been a great move and has been a driver behind the shares this year so far. Low wage growth and higher social security taxes has put pressure on the spending power for Dollar General's target customer base.

Yet all of this is not great news for the company. Some of its "customers" are so desperate that they increasingly opt to steal the products instead of paying for them. While tobacco sales have been a driver of growth, further growth could be achieved by the introduction of national brands.

While the operational performance continues to be solid, I think the valuation is more than fair enough at these levels. Strong comparable sales growth won't last forever, which combined with a reasonably high valuation makes me a bit cautious.

I remain on the sidelines.

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.