Is Aldi a Threat to Dollar General?

There is a major U.S. retailer that is threatened by the explosive growth of Aldi and it is not Wal-Mart Stores Inc. (NYSE: WMT) or Kroger (NYSE: KR). Instead, the discounter most threatened by Aldi’s relentless U.S. expansion is Dollar General (NYSE: DG).

The German-based and privately-held Aldi is clearly competing for Dollar General’s customers with a bare bones operation and very low prices. In December 2015, Business Insider reported that a basket of groceries from Aldi was 30% cheaper than one of the same goods from Wal-Mart.

How Aldi Threatens Dollar General

Aldi is a planning a massive expansion in the United States, with plans to open 600 additional stores over the next two years. It already operates around 1,400 stores in 32 states and is planning to enter new markets such as Southern California. The LA Times reported that Aldi is building a distribution center in Moreno Valley, Ca., just outside Riverside, and plans to open 45 stores in Southern California.

In a 2014 price comparison of several major discounters, Kantar Retail found that Aldi had the lowest prices for edible items – its shopping bag of food cost $9.77 while Dollar General’s cost $12.25, a $2.48 difference. Dollar General’s nonedible items were cheaper than Aldi’s, but only by $1.94. The Dollar General items cost $9.50, while the Aldi stuff cost $11.44.

This is a threat to Dollar General because Wal-Mart and Kroger have other sources of revenue besides direct retail discounting. Wal-Mart has its online operations, gas stations, pharmacies, and lots of big-ticket items Aldi would never touch, such as consumer electronics and chainsaws. Kroger has pharmacies, delis, 1,330 fuel centers, cafes, delis, coffee shops, 782 convenience stores, and even 326 jewelry stores to generate additional revenue.

All of Dollar General’s revenues come from brick and mortar discounting, and that’s a big problem if Aldi opens up in the strip mall with a better selection of groceries, and lower prices. Aldi is not a traditional supermarket; instead, it is a discount grocer with a very limited selection of private label items. Aldi also offers a variety of products that Dollar General lacks, including fresh vegetables and meat.

It is clear that Aldi is going after the same kind of less discriminating price-minded customers as Dollar General. Aldi keeps overhead low, with such strategies as limiting hours of operation, making customers bring their own bags, and charging for shopping carts.

Aldi’s Expansion at a Bad Time for Dollar General

Aldi’s expansion is coming at a bad time for Dollar General because the company is planning to open 1,000 new stores and remodel 900 others in 2017, Chain Store Age reported. Dollar General’s store count was 12,483 stores as of Jan. 29, 2016.

This means that Dollar General is going through a massive expansion, just as an aggressive new rival is launching a major offensive for its core customers. It also prompts an important question: Does Dollar General have the resources to expand and fend off an Aldi attack at the same time?

The answer might be no, despite Dollar General’s impressive revenue growth in recent years. It reported a TTM revenue of $20.37 billion on Jan. 31, 2016, up from $18.91 billion in January 2015 and $17.5 billion in January 2014. That revenue growth looks impressive, but it might be coming from expansion rather than increasing same store sales.

Dollar General opened around 900 new stores in 2015, Chain Store Age reported. One has to wonder if this revenue is generated by organic growth or simply the byproduct of mindless expansion, particularly since that expansion does not seem to be increasing Dollar General’s cash flow.

Where’s the Cash?

Dollar General reported a net income of $1.165 billion in January 2016, a $100 million increase from January 2015 when it reported $1.065 billion. This figure indicates the chain only generated $100 million in additional income from 900 new stores, which does not sound good. It also casts doubt upon the 7.12% profit margin that Dollar General reported.

Another bothersome figure is cash from operations. Dollar General reported $1.315 billion in cash from operations in January 2015 and $1.378 billion in cash from operations a year later. By my calculations, the difference between those figures is $6.3 million, which casts a lot of doubt on Dollar General CEO Todd Vasos’ claims of “strong cash flow.” Dollar General only gained $6.3 million in additional cash from operations last year even though it opened 900 new stores in 2015.

What’s more frightening is Dollar General’s cash and short-term investments. Dollar General reported having $579.82 million in the bank in January 2015 and $157.95 million in the bank in January 2016. From those numbers, it looks as if Dollar General spent most of its cash on expansion, and the expansion does not seem to be adding to the cash flow.

Is it Family Dollar All over Again?

Now the chain is launching yet another around of expansion as competition heats up. I have to wonder how long the company can keep spending all of its cash on expansion. Will Dollar General end up like Family Dollar and run out of cash at some point? Family Dollar also expanded mindlessly for several years before running out of money and selling out to Dollar Tree Stores (NASDAQ: DLTR) to avoid the death spiral. Such a scenario is likely because some media reports indicate that Dollar General’s management believes they can open as many as 20,000 stores in the U.S.

My advice to investors is to stay away from Dollar General because it is playing a dangerous game of expansion in an increasingly complex and competitive market. That market is made all the more dangerous by the growing presence of such an aggressive rival as Aldi.

To make matters worse, its stock is on the verge of being overvalued. On March 24, 2016, Dollar General reported a market capitalization of $24.05 billion and an enterprise value of $24.05 billion, figures that were equal. It looks as if this stock has limits of its price, even as the company itself may have reached the limits of expansion.

Disclosure: the blogger owns shares of Kroger.