Ignore The Discount Retail Merger Hype And Just Buy Dollar General

| About: Dollar General (DG)

Summary

Ignore the hype about the Dollar Tree-Family Dollar merger; Dollar General is where you want to be.

Dollar General is the leader of the discount retailers and it has the financials to back it up.

With only a few controllable risk factors to consider, this well-oiled machine is set to break out.

Dividends be darned, still make out like a bandit with a near 12% shareholder yield.

The Situation

While the talking heads on Wall Street blabber on about Dollar Tree (NASDAQ:DLTR) acquiring Family Dollar (NYSE:FDO) for $8.5 Billion and how much money it will make for Carl Icahn, shareholders of Dollar General (NYSE:DG) know they own the better company. The consolidation of the discount dollars will certainly be an interesting story to watch as it unfolds. However, if you are a prudent investor looking to only buy the best companies with great brand names at fair prices, then you need not look further than Dollar General.

DG is clearly the industry leader and was crushing both of its major competitors prior to the merger. While Dollar Tree and Family Dollar will now combine to exceed the market cap of DG, it still remains to be seen if the businesses can integrate smoothly.

So we say, don't worry about it and just go buy the best! Dollar General is a solid company on strong financial footing and should be on the radar screen of every long-term investor. While the other dollar discounters scramble to work out the details of the merger, DG will continue minting money while growing its brand and market share.

The Numbers

When looking at DG's financial statements, the first thing that jumps out is that it does not pay a dividend. This might disappoint many income-oriented investors and quite possibly turn them off to the stock all together.

It's a shame, as DG is such a strong company. But, this is understandable, given the near-zero interest rate world in which we live.

However, hear us out on this one as we think it is quite evident that DG has many other key factors in place that can offer you significant long-term benefit while you wait for the dividend checks to start rolling in (which we believe it could easily handle in the near term). The most important of which is that DG bought back over $1.4 Billion in stock over the past year. Combine that with its steady stream of Free Cash Flow and reasonable borrowings and you get a nice annualized shareholder return / yield of almost 12%.

After scanning over DG's financials, this company is a powerhouse that knows how to make money. Highlights include a Gross Profit Margin of over 30%, a Return on Equity of over 21% and a Current Ratio of 1.58. The company sports an Enterprise Value to EBITDA of just 9.77, a Price-to-Book value of 3.47, a Price-to-Earnings Ratio (-ttm) of 16.3 and consistent net margins over the past year.

It's not super bargain basement cheap, but it's not expensive either. For the quality of business you're getting here, today's price is certainly acceptable. Plus, the future growth and possibility of receiving dividends in the near-term make it a no-brainer.

(Below based on trailing-twelve months of quarterly SEC filings)

Operating Margin: 9.7%
Net Profit Margin: 5.8%
Return on Equity: 21.3%

Price-to-Earnings: 16.3
Price-to-Book: 3.47
Price-to-Sales: 0.94
Price-to-Cash Flow: 12.72

Current Ratio: 1.58
Debt-to-Equity: 1.19
Stock Repurchased : $1.4 Billion
Shareholder Yield: 11.9%

Competition

Now, after looking at Dollar General's financials, let's run a quick comparison to some metrics of Dollar Tree and Family Dollar. Since we cannot know exactly how the metrics will look after the merger, we will simply look at each company as an individual competitor and expect the final post-merger result to be somewhere in the middle.

Metric DG DLTR FDO Winner
P/E 16.3 19.5 22.3 DG
P/CF 12.72 13.12 21.62 DG
P/B 3.47 8.55 5.14 DG
P/S 0.94 1.41 0.82 FDO
EV/EBITDA 9.77 9.88 11.34 DG
D/E 1.19 57.44 46.87 DG
Div Yield N/A N/A 1.8% FDO
ROE 21.3% 39.4% 22.2% DLTR
OP Margin 9.7% 12.4% 5.4% DLTR
Net Margin 5.8% 7.5% 3.4% DLTR

Dollar General displays better performance in 5 of the 10 metric categories. Dollar Tree appears to have a slight edge in terms of ROE and Operating/Profit Margins but in each case where DLTR was ahead, it's not a significant differential from DG. Plus, DLTR now has to deal with ramping up FDO to match this pace, which will take time to play out considering FDO managed to come in last place in half of the above categories.

The Facts

According to DG's website, the company is the largest discount retailer in the United States by number of stores with over 11,000 neighborhood stores in 40 states and is among the largest retailers of top-quality products made by America's most trusted manufacturers.

This garners our attention because we're all about the brand-power. Since the market is fascinated with the merger story of the other dollar discounters, we feel as though investors are missing the boat when it comes to who is #1. DG has better fundamentals, better locations, better leasing structure at its properties and the financial stability to continue dominating the space into the foreseeable future.

Also, DG just recently successfully rolled out a new digital coupon program with the popular discount website Coupons.com. From Dollar General's press release:

"The DG Digital Coupon program provides our customers with an easy-to-use and convenient platform to use digital coupons toward our everyday low prices, helping them get the products they need at prices they want," said Todd Vasos, Dollar General's Chief Operating Officer. "Understanding our shopper is utilizing digital and online technology to help save money, the completion of this project not only demonstrates our ability to deliver everyday value and affordable options to our customers, but also our commitment to help our customers save time and money, every day."

The other tailwind for DG and the discount retail space in general is the ailing middle class in America. Average folks are not left with many options when it comes to shopping for branded food and home products outside of big box stores like Wal-Mart and Target, which have been feeling the squeeze of the debt-burden and wage deprived middle class.

The trend of shoppers looking for deals closer to home will continue to drive sales and growth for DG going forward. It will clearly have to compete with a larger adversary post-merger of Dollar Tree and Family Dollar, but that time is in the future. In the meantime, DG will just continue going about its business, which is doing quite well.

The Risks

Our analysis would not be complete without a few caveats for the stock in question. Dollar General, as with all growing companies, does face some challenges. The obvious risk factor is what we already mentioned, in that the competition is mobilizing against DG and is now that much bigger and has more reach. But the impact is yet to be determined, so this risk is not front-and-center at the moment.

More intriguing to the common shareholder would be the fact that DG does not pay a dividend. This is clearly something that income investors like retirees are seeking. However, on the flip side, every portfolio needs stocks like DG to provide future growth and the possibility of capital gains through share price appreciation.

Other items to watch out for with DG are its debt and cash levels. It currently has a Debt-to-Equity ratio of 1.19, which ideally we'd like to see reduced given that the cash flow appears to be steady, CapEx seems to be stabilizing and no dividends are being paid. However, cash & equivalent levels are relatively low at $166.3 Million. This makes the Price-to-Cash considerably high at the current market cap of $16.75 Billion.

Conclusion

After weighing the risks and rewards, Dollar General is the king of the discount retailers. The company has a known brand, make steady profits and generate solid cash flow. Growth potential is high and while the lack of a dividend excludes it from most income investors' short list, the quality and future outlook for DG is very strong. Ignore the chitter chatter by the Street about the recent merger and focus on buying the best of the bunch. At the current market price, you can pick up shares of DG for just 0.94 times trailing-twelve month's sales! Give it some thought and see if you have room in your portfolio for this industry leader.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.