Thanks to recession and a long, slow recovery, discount stores including dollar stores like Dollar General (NYSE:DG), Family Dollar (NYSE: FDO) and Dollar Tree (NYSE: DLTR) are enjoying a great run. The following chart summarizes these companies’ impressive run up since March’09.
Going forward, we believe the dollar stores have strong long term prospects as consumers are likely to continue to shop for bargain prices and discount products given slower than expected recovery and abnormally high unemployment rate. Dollar Tree has seen its stock almost quadruple over the past three years and is trading close to its all-time high, but its premium valuation gives it little margin for error. Dollar General on the other hand is not overvalued, and we believe the company has strong growth prospects. Strictly speaking, Dollar General is not a dollar store as many of its offerings are priced at more than one dollar. However, the company is continuously increasing $1 items. Items costing $1 now represent 26% of Dollar General’s assortment, up from 23% two years ago and the company is planning to take this figure to 28% this holiday season. The following are the key reasons we remain bullish on this stock.
Promising Merchandising Initiatives
Dollar General has made significant improvements to its merchandise assortment and store environment since 2007, which has increased the company’s appeal to customers. Dollar General continues to add coolers (to drive traffic and ticket) and re-merchandise key categories. The company has been very successful in attracting a wider customer base to shop its stores. Going forward, the company’s increasing focus on greeting cards, stationary, arts & crafts and $1 price point items is a positive move and can result in market share gains from Dollar Tree in the coming quarters.
Store Optimization
The company is clustering stores to customize merchandise based on the geography demographics of the area. Dollar General has worked to standardize its stores to improve operations and it will begin customizing the assortment based on consumer demographics and preferences. We believe this is a large opportunity for the company as store optimization has been one of the main drivers of Dollar Tree’s success after it began doing this about three years ago.
Roll-out of Beer and wine
Alcohol is available in around 3,700 stores and will increase to 5,000 by year end. We are encouraged by this plan of rolling out alcohol in 60% of the total stores as adding alcohol will significant increase the average basket size. Adding cigarettes to stores was also considered but management noted that domestic tobacco market is declining, while beer and wine sales are increasing and the beer/wine market is nearly twice the size of the tobacco market.
Ample Growth Opportunities
The company has ample opportunities for square footage growth. At present the company has over 10,000 locations and believes it can sustainably grow by a 7% annual rate. While the traditional Dollar General box will continue to be the backbone of company’s operations, the DG Market and DG Plus formats are growing in importance and will lead growth in many new markets, including California. Encouragingly, stores in California are doing well, with store volumes higher than the average store volume. The company has plans to open 50 stores in the state by the end of the year. We believe that California can hold the same number of stores as Texas.
Early Indication of Good Q2 results
Treehouse Foods (NYSE: THS) is the private brand food manufacturer and Dollar General’s private brands represented 23% of Treehouse Foods’ total consumable sales in FY11. Earlier, this month Treehouse Foods reported its 2Q12 results which showed declining sales at traditional grocery stores, but increasing sales at discount and limited assortment retailers including Dollar General. Thus, it is an early indication that Dollar General is set to report good Q2 results in September.
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