Just in the last week we’ve seen numerous headlines relating to the increased risk of the US economy entering a recession within the next 12 months. Are these articles and predictions correct? Your guess is as good as mine! What we do know is that we are currently in the midst of the longest bull market in US history. Does that mean it has to stop anytime soon? No, but given where we currently are, I believe it’s prudent to start thinking about adding names to your portfolio that should perform well during an economic downturn.
Dollar General (DG) is a $36 billion dollar-store chain in America. With more than 15,000 stores in 44 states, it is the largest small box retailer in the US. The company specializes in low-cost consumer necessities, items that need to be replaced frequently. Their core products include food, snacks, cleaning supplies, basic clothing, beauty products, and houseware. Almost all of the items in the store cost less than $10.
The company’s strong competitive advantage, understanding of its customer base, and antifragile business not only provide a buoy, but help the company thrive during times of economic stress. Dollar General is a name you can confidently put in your portfolio to prepare for the time when this decade long bull run eventually comes to an end, whenever that might be.
The Competitive Advantage
I could describe Dollar General’s competitive advantage to you, but I think from CEO David Perdue said it best, “We went where they ain’t and offered 7-Eleven convenience at Walmart prices.” The main reason why Dollar General was able to grab such a large market share, and keep it, is because they were, and are, willing to go to places larger companies like Walmart and Target are not.
Dollar General thrives in small towns. Around 75% of the company’s stores are located in small towns with populations of less than 20,000. The majority of these towns don’t have another option for their household necessities and groceries. The places Dollar General dominates are too small and impoverished for the big-box stores to operate their business models profitably, which means Dollar General will be free to continue to operate its business with basically zero outside threat from brick-and-mortar retailers.
But what about Amazon?
Dollar General doesn’t have much to worry about on that front either. The majority of the company’s customers have annual household incomes under $50,000, with 33% under $25,000. Their customers simply cannot afford the monthly subscription fee to Amazon. Also, consumers have shown some reluctance to buying their food products online, which is a large part of Dollar General’s business.
On top of the lack of competition, Dollar General’s understanding of its customer base will make it very difficult for someone else to attempt to enter their space. Minor details such as pricing all their goods in 5 cent increments to make budgeting while shopping easier and designing an app where coupons are automatically applied to orders are just a few of the strategic initiatives the company has taken directly targeted at the people who shop at their stores.
An Antifragile Business
When the US economy eventually contracts, Dollar General’s top line will not only be well protected, but it might actually grow. Regardless of the economy, Dollar General’s low-income customer base will still need to shop for their necessities. But when times get tough, consumers will face increased financial pressure and those who wouldn’t normally shop at Dollar General may be forced to turn to the discount retailer for their cheap prices and convenience. This is the definition of an antifragile business, a business that grows stronger under times of stress.
The Wall Street Journal described this phenomenon well in 2017, specifically relating it to Dollar General. The author wrote, “Dollar General is expanding because rural America is struggling. With its convenient locations for frugal shoppers, it has become one of the most profitable retailers in the US and a lifeline for lower-income customers.”
Dollar General went public at the end of 2009, which was in the midst of the Great Recession. The company was trading for less than two months before the economy turned upwards, so unfortunately we cannot look to the past to see how Dollar General has performance in previous recessions. What we can do instead is analyze a similar business that is often considered “recession-proof” and see how Walmart performed during that the last economic crisis.
In 2008, Walmart returned an incredible 21% (including dividends), while the S&P 500 was down 38%. During that same year, while the entire country was struggling, Walmart’s revenue grew 8.5%. Much like Walmart, Dollar General’s business should thrive when the country struggles and potentially could perform even better.
An Advantage Over Walmart
Dollar General certainly won’t be challenging Walmart in market cap anytime soon, but it does have a few advantages that should allow it to outperform during a recession. One advantage is the massive difference in store size between Dollar General and Walmart. Dollar General’s unique store concept is one of the biggest reasons the company has been able to deliver such competitive prices. Their average store size is 7,400 square feet, which is smaller than two basketball courts. Compare that to Walmart, which has an average store size five times larger, or Walmart supercenters, which average around 187,000 square feet, and you can see why it will be much easier for Dollar General to remain nimble during times of economic distress.
The company’s smaller footprint means Dollar General has the flexibility to strategically expand into locations where there’s less competition and consume much less capital while doing so. The average Dollar General store costs around $250,000 to build, which is just a fraction of Walmart spends to open a store.
Another advantage is that Dollar General doesn’t even own most of its stores. It leases them from landowners who built them to the company’s exact specifications. Rather than having to come up with all of the capital for new stores up front, this leasing strategy allows Dollar General to spread costs out at each location over 15 years. Dollar General is able to maintain capital efficiency by not tying their cash up in real estate, which is an effective strategy in almost any economic climate, but especially during a recession.
What if There's No Recession
Just because we have gone over a decade without a recession does not mean we can’t go another decade before the next economic downturn. If that’s your opinion, I still think adding Dollar General to your portfolio is worth considering. CEO Todd Vasos has outlined three key initiatives to drive a more affluent traffic through its stores, which should help the company elevate profit margins and grow even during the good times.
The first initiative is to expand the refrigerated area in all of its stores to increase the selection of perishable items such as milk and bring in new, higher-end products like Starbucks drinks. Dollar General same store sales have risen from 0.9% in FY 2017 to 3.2% in FY 2019. Increased refrigeration capabilities certainly doesn’t deserve all the credit for that rise, but Vasos has said it has been the company’s most impactful merchandising initiative. I expect this trend to continue as Dollar General starts the next phase of its cooler project, “DG Fresh”, which is the self-distribution of fresh and frozen products.
The second initiative is Dollar General’s move into the low-end beauty segment. In the past year the company launched a new label, Believe Beauty, which is an extensive collection of beauty products all prices under $5. This should draw a new type of customer to Dollar General, the person with enough money to spend on beauty supplies.
The final initiative to drive traffic is the development of the Dollar General app. The app allows customers to search for available coupons and clip them directly on the app. If the initial app is successful the next step of the project is to allow customers to scan items as they shop and not have to wait in check out lines. This will allow customers to track their costs as they shop instead of having to wait for the final amount at the register. The initial rollout of the app has been considered a success with over 300 million coupons clipped in the first quarter of 2019.
Dollar General produces some of the highest EBITDA per square foot of retail space in the industry.
|Company||EBITDA per Square Foot|
|Big Lots (BIG)||$12.96|
|Dollar Tree (DLTR)||$17.79|
|Dollar General (DG)||$24.51|
When looking at this table remember what I just told you about the difference between the amount Dollar General is investing in its stores and what Walmart is investing in its stores. Dollar General is generating Walmart like store economies for a fraction of the investment.
The result is Dollar General’s industry leading returns on invested capital (ROIC). Notice in the table below that Dollar General is the only one of its peers where this number is actually increasing over the past five years.
|Year||Walmart||Dollar General||Big Lots||Dollar Tree|
Predicting when the next recession will occur is nearly impossible. It could be three months from now, or it could be a decade from now. What we do know is that we are currently in the midst of one of the longest economic booms in US history and it wouldn’t hurt to prepare for the inevitable downturn. Dollar General thrives as more people struggle financially and I believe the same thing will be true of its stock, rising as others will fall.
Disclosure: I am/we are long DG. 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.