Dollar General: Decent Quarter, But Valuation Is Stretched Amidst Slowing Growth

| About: Dollar General (DG)

Shares of Dollar General (DG), the discount retailer in the United States, rose 0.8% in Wednesday's trading session. Before the market open, the company reported a decent set of quarterly results.

Second Quarter Results

Dollar General reported second quarter revenues of $3.95 billion, up 10.4% on the year. Same-store sales, rose 5.1%, driven by increased customer traffic and an average transaction amount. Consumable sales continue to increase faster than non-consumables in the quarter, driven by growth in snacks and perishable foods. Revenues came in a touch below analysts expectations of $3.96 billion.

Operating margins remained unchanged around 9.8%, resulting in an operating profit of $387 million. Selling, general and administrative expenses fell by 15 basis points to $22.2%.

Net income rose by 47% to $214 million, up from $146 million last year. Adjusted net income rose 27% to $231 million. Adjusted diluted earnings per share rose by 33% to $0.69 in the second quarter. On average, analysts expected the company to earn $0.64 per share.

The board of directors authorized the repurchase of another $500 million of its common stock. This brings the total current authorization to $515 million, as the company repurchased 11.7 million shares for approximately $485 million over the past half year. Despite the repurchase plan, the company has almost 10% more shares outstanding compared to 2008. Management is issuing stock while it is trading low, while repurchasing it at current higher levels.

Chairman and CEO Rick Dreiling commented on the results,

Dollar General had another strong quarter. Our same-store sales increase of 5.1% demonstrates the ongoing execution of the initiatives around our key operating priorities and is evidence of our continued importance to our customers.

Outlook

For the full year of 2012, Dollar General expects total sales to increase 8 to 9% on a 53-week basis. On a 52-week basis, revenue growth is 2% higher. Same store sales, are expected to increase by 4-5%, compared to an earlier forecast of 3%.

Operating profits are expected to come in between $1.64-$1.66 billion, largely in line with the previous guidance. Non-GAAP EPS are expected to come in between $2.77-$2.85 for the full year. Earlier, the company guided for full year earnings between $2.68-$2.78 per share.

For the full year of 2012, the company plans to open 625 new stores, including 40 Dollar General Market stores. Total capital expenditures are expected to range between $600-$650 million.

Valuation

Dollar General ended its second quarter with $134 million in cash and equivalents. The company operates with $2.89 billion in short and long term debt, for a net debt position of $2.76 billion.

For the first six months of 2012, Dollar General reported revenues of $7.85 billion. It net earned $428 million, or $1.27 per diluted share.

The market currently values the firm at $17 billion. Based on the full year outlook, Dollar General values the firm at roughly 0.9 times annual revenues and 18 times annual earnings.

Dollar Tree (DLTR) trades at 1.7 times annual revenues and Family Dollar Stores (FDO) at 0.9 times. These competitors trade at 21 and 18 times annual trailing earnings, respectively.

Currently, Dollar General does not pay a dividend.

Investment Thesis

Year to date, shares of Dollar General trade with gains of roughly 25%. Shares steadily rose from $40 to $55 in June, but fell to $50 in recent weeks. Shares steadily rose upwards over the past few years.

The company significantly expanded its business. Dollar General reported revenues of $10.5 billion in 2008, to an expected $16 billion in 2012. Net income rose from $108 million in 2008 to an expected $900 million in 2012. Earnings per share rose from $0.34 to an expected $2.81 in 2012.

In June of this year, I already looked at the prospects of Dollar General. I concluded that the valuation was already reasonably stretched. Recent earnings growth was driven by both revenue growth and margin expansion. Same store sales growth is slowing from 6.7% in the first quarter to 5.1% in the past quarter. Net margins have steadily rise to almost 6% in 2012, but I cannot see them moving consistently higher into the future.

A trend break in margin expansion or revenue growth could cause a lot of panic amidst investors, who clearly value Dollar General as a growth stock.

Today, I reiterate my stance and I will not touch the shares at the moment.

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.