Dollar General: Valuation Is Too Stretched

| About: Dollar General (DG)
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Shares of discount retailer Dollar General (NYSE:DG) fell 3% in after hours trading as the company announced its first quarter results after the market close.

First Quarter Results

Dollar General reported a 36% increase in first quarter net income to $213 million compared to $157 million last year. Adjusted net income increased 29% to $215 million as large year's net profits were impacted by litigation expenses. Diluted earnings per share rose 40% to $0.63. The company reported a 13.0% increase in net sales to $3.90 billion, driven by a 6.7% growth in same store sales. Both store traffic and average transaction amounts increased.

Gross margins remained stable at 31.5% as an improvements in transportation efficiency and lower inventory levels were offset by the impact of markdowns. The company reduced selling, general and administrative expenses by 0.6% to 21.6% of total sales due to the impact of litigation expenses last year.

"Dollar General is starting off 2012 with strong performance in the first quarter due to excellent same-store sales growth of 6.7 percent, representing the fifth consecutive quarter of accelerating improvement," according to CEO Dreiling.


On the back of the strong first quarter results the company is raising its forecast for the entire year of 2012. The company expects a 8 to 9% increase in total sales on the year, driven by same store sales growth of 3 to 5%. Operating profits are expected to come in between $1.62 billion and $1.66 billion. General Dollar now guides for full year diluted earnings per share to come in between $2.68 and $2.78 per share, an increase of $0.03 from its previous full year guidance.

The company guides to open 625 new stores for the entire year of 2012. Furthermore it will relocate or remodel some 550 stores. Capital expenditures will come in between $600 and $650 million. At the end of the first quarter the company operated 10,052 stores across the nation.


Dollar General ended its first quarter of 2012 with $133 million in cash and equivalents. The company holds $2.88 billion in long term obligations and carries a massive goodwill balance of $4.3 billion on its balance sheet. Including the decline in after-hours trading, shares are valued around $16 billion which values the discount retailer at 1.1 times annual revenues and 21 times 2011s annual earnings.

This valuation compares to an annual revenue multiple of 0.9 times for Family Dollar Stores (NYSE:FDO) and 1.7 times for Dollar Tree (NASDAQ:DLTR). These competitors trade 20 and 24 times annual earnings, respectively.

Currently the company does not pay a dividend.

Investment Thesis

Shares in Dollar General have seen a steady upwards trend in recent years. Trading as low as $22 in the beginning of 2010 shares have peaked at $49 last week. Years of double digit revenue growth accompanied by expanding margins, led to strong profit growth which fueled the rally in the shares.

While the company is still expecting an increase in full year profits, the pace of the growth in earnings is slowing down amidst a decrease in revenue growth and margin stabilization. Valued at 21 times 2011s annual earnings, shares offer limited upside as the valuation is already fairly stretched.

With a slowdown in revenue growth and margins topping around the 5% level 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.