With the economy recovering at a painfully sluggish rate, many retailers are trading cheaply. While the S&P 500 trades at 20.8x past earnings, Walmart (WMT) and Target (TGT) trade at just a respective 13.4x and 12.8x past earnings. Dollar General (DG) is one of the few retailers to be valued at a similar multiple to that of the S&P 500. In this article, I will run you through my DCF model on Dollar General and then triangulate the result against a review of the fundamentals of Walmart and Target. I expect these two cheaper retailers to outperform Dollar General as the economy advances towards full employment.
First, let's begin with an assumption about the top-line. Dollar General finished FY2011 with $14.8B in revenue, which represented a 13.6% gain off of the preceding year. I model a 16.3% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold to eat 68% of revenue versus 22% for SG&A, and 2.5% for capex. Taxes are estimated at 37% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital. I estimate this figure hovering around 0.8% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 9% yields a fair value figure of $41.50, implying that the stock is around 9% overvalued.
All of this falls within the context of overall strong operating performance:
"[W]e had a great year and we had very strong financial performance in the fourth quarter, with sales above our expectations.
Fourth quarter sales were again driven by consumables, which generally have a lower gross margin than non-consumables. Our fourth quarter gross profit rate was 32.2%, a decrease of 25 basis points from the 2010 fourth quarter, which as a reminder was the highest gross margin performance we have ever achieved. Purchase costs were up year-over-year, particularly on some of our food items such as sugar, coffee and nuts, resulting in a likely charge of $22 million for the quarter, much higher than we had anticipated at the end of Q3 as inflation continued at a higher rate than expected. Overall though, we are pleased with our gross margin results for the quarter".
From a multiples perspective, the stock is expensive relative to peers. It trades at a respective 20.1x and 14.1x past and forward earnings versus 13.8x and 11.8x for Walmart and 12.9x and 11.4x for Target.
Consensus estimates forecast Walmart's EPS growing by 8.2% to $4.86 in 2013 and then by 8.8% and 9.5% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $5.22, the stock would hit $73.08 for 17.1% upside. For a stock that offers a 2.7% dividend yield and a beta of 0.4, Walmart is an attractive defensive company. It is currently rated a "buy" on the Street (source: NASDAQ).
Consensus estimates forecast Target's EPS growing by 0.9% to $4.31 in 2013 and then by 13% and 19.1% in the following two years. Of the last 18 revisions to EPS, 16 have gone up for a net change of 0.8%. This retailer also is rated a "buy" on the Street (source: NASDAQ) and has excellent expansion potential. Assuming a multiple of 14x and a conservative 2013 EPS of $4.84, the stock would hit $67.76 for 22.2% upside.
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