The most surprising retail success story in America today is that at Dollar General (NYSE: DG). Business is booming at the bottom-feeding small box operator even though it seems to break all the modern retail rules.
On April 30, 2015, Dollar General reported a year to year revenue growth rate of 8.77%. That was far better than the industry leaders. On the same day Walmart Stores Inc. (NYSE: WMT) reported a rate of -.12%, and Target (NYSE: TGT) reported a rate of 2.77%. A chain often cited as the biggest success story in modern American retail, Costco Wholesale (NASDAQ: COST), reported a rate of just 1.19%.
It is not just the rate of revenue growth at Dollar General that is impressive; it is the amount of revenue growth. Dollar General reported a TTM revenue of $17.79 billion in April 2014 that grew to $19.31 billion in April 2015. That is an increase of $1.52 billion in just a year; that’s impressive for a company with an enterprise value of just $24.67 billion.
Dollar General’s Growth Now Exceeds Target’s
If that wasn’t enough, the amount of Dollar General’s revenue growth actually exceeded that of Target. The numbers indicate that Target’s TTM revenue increased by $1.46 billion between April 2014 and April 2015, rising from $71.23 billion in 2014 to $72.69 billion in 2015.
Investors shared in the growth too; Dollar General reported a return on equity of 20.79% and a profit margin of 5.15%. It also reported an earnings per share number of 3.617%, which is approaching Walmart’s 4.971%. Chart watchers also know that Dollar General’s EPS has been increasing for some time; in April 2014 it reported an EPS of 3.22%, and in April 2013 it was 2.895%.
How Dollar General Breaks the Rules
The truly fascinating thing about Dollar General is that it breaks a lot of the present day retail rules. It operates basic bare bones discount stores selling low-end merchandise at very low prices.
Dollar General also caters to lower class customers and operates stores in places that other retailers shun. Many of its stores are in rural communities in the South, Midwest, and West. It also regularly makes the lists of the worst companies in America to work for.
Dollar General also sells lots of politically incorrect items. In an age of concerns about health and fashionable organic foods, some of the chain’s biggest profit drivers are tobacco, candy and snacks like potato chips. Forbes contributor Maggie McGrath estimated that such vices may account for 4% of Dollar General’s sales. McGrath thinks that increased sales of candy and cigarettes might be driving Dollar General’s recent sales growth.
Despite all this, or perhaps because of it, Dollar General is very successful. Yet one still has to ask what is driving Dollar General’s success. What factors can investors identify to look for similar attributes at other retailers?
Why Is Dollar General So Successful?
Personally, I think that a number of factors and converging trends account for Dollar General’s success. These trends and factors include:
- Growing income inequality. Large numbers of American simply do not have that much money. The Wall Street Journal reported that 2 million Americans were on food stamps in May 2015. Last year The Washington Post reported that incomes in 81% of the counties in the United States were lower than in 1999. Many people simply do not have enough money to shop at larger stores, so they are going to small box stores like Dollar General. People that can barely afford food are apt to run into Dollar General to buy a $1 candy bar; they are not likely to drive out to Costco to spend $100 for an electric razor. Dollar General is one of the companies well positioned to take advantage of growing income inequality.
- Dollar General fits in with the shopping habits of millennials—people that came of age after 2000. As I noted over at Seeking Alpha, there is growing concern that such people do not shop at big box stores like Costco. Instead, they favor smaller neighborhood-oriented stores like Dollar General. Millennials also are less likely to drive and live in houses, which means that they are more likely to buy smaller quantities of items that Dollar General sells.
- The growth of online retailers like com (NASDAQ: AMZN) could actually benefit neighborhood-based small box retailers. Many people now make many of their larger purchases, such as those for shoes, electronics and clothes, online. That gives people less incentive to make the run out to the big box store to pick up laundry detergent or diapers. Why make the trip when Dollar General is right in the neighborhood? If you need a new printer or a pair of shoes, Amazon.com will ship those to your door at no extra cost.
- Dollar General is one of the few national retailers left making a strong push for the lower middle class and working class customer and rural customers. Chains like Costco and Target seem to be concentrating their marketing efforts at various segments of the upper class. To that end, Dollar General sells lots of junk food and soda pop, sells lots of low-end groceries and even markets cigarettes. It is also one of the few retailers that has not jumped on the organic band wagon. To promote its working class image, Dollar General sponsors a NASCAR race car and buys lots of advertising in small town newspapers.
- Interestingly enough, another retailer that’s made a strong push for the working class customer, Kroger (NYSE: KR), is also doing very well. Kroger reported a revenue growth rate of 8.55% on Jan. 31, 2015, similar to that at Dollar General. Meanwhile, some companies with a strong middle class appeal like Sears and JC Penney have struggled mightily in recent years.
- One possibility is that Dollar General is serving a growing demographic while Sears and JC Penney are serving a shrinking consumer base. As the middle class shrinks, Dollar General’s potential customer base grows.
The Billion Dollar Question
Now for the billion dollar question: Can Dollar General keep it up? That is hard to say. The company just opened its 12,000th store, in Juliette, Georgia. It also has ambitious expansion plans with a design to add 900 additional stores over the next year.
One has to wonder when this company will hit saturation point. It could end up just like Family Dollar did and reach a point at which expansion costs start eating up the revenues.
Another bump in the road is aggressive competition from Walmart, drugstores like Walgreens and Kroger. Walmart is opening locations of its small box concept, Walmart Neighborhood Market, right and left and plans to add 270 to 300 such stores a year for the foreseeable future.
Walgreens and CVS Health have doing very well in recent years largely because strong growth in prescription demand is driving customers into their small box locations. One reason for this is that Obamacare has increased the number of people on insurance, creating more drugstore customers.
Kroger has adopted a highly successful strategy of aggressive discounting that directly challenges dollar-store operators. Like Walmart, it can also offer customers amenities that Dollar General lacks, including gas stations, pharmacies and full-service grocery sections.
How Amazon Could Threaten Dollar General
On the horizon is Amazon.com, which is making an aggressive push into the grocery business by offering its own private label foods and household cleaners. Amazon presents a direct challenge for small box retailers because it reaches urban and rural customers that may not shop at big box stores.
At the small-town post office I use, I regularly see customers picking up Amazon boxes. If Amazon can start offering groceries, diapers and laundry detergent at prices similar to Dollar General’s with free delivery, it could be a major threat to small box retailers.
Walmart.com is another potential menace here because its online capabilities are starting to rival Amazon’s. Walmart’s deep discounting capabilities exceed Amazon’s, which could give it an advantage in the online retail battles. If an all-out online grocery war erupts between Amazon and Walmart (and I think one is coming fast), Dollar General could be the biggest casualty.
My prediction is that Dollar General will keep growing for a while, but it is headed for a crash sooner or later. I simply do not see how the massive growth at this retailer can be maintained in the face of all that competition.
Disclosure: The blogger owns shares of Kroger.