Is Dollar General’s Growth Sustainable?

The ever-growing revenues at Dollar General (NYSE: DG) indicate that the dollar-store boom is far from over. Yet the company’s financial numbers cast serious doubt on the sustainability of Dollar General’s breakneck growth.

Dollar General already operates 12,483 stores in the United States according to Google, making it the largest discount retailer by foot print. Disturbingly that empire is not enough for CEO Todd Vasos.

Back in March, Vasos announced plans to open another 1,000 stores in 2017. That’s on top of the 900 stores the company planned to open in 2016.

At the same time Vasos released what he called a “powerful strategic plan” that would increase net sales by 7% to 10%, square footage by 6% to 8%, same store sales by 2% to 4%, diluted earnings per share by 10% to 15% and cash from operations by 7% to 8%. Oh yeah Vasos’ also boasted that shareholders would see a return of 11% to 17%. No I’m not making this up, Dollar General released a press release with these claims.

Is Dollar General’s Growth Slowing?

Okay it is impossible to tell the future but there is one way we can partially check the veracity of Mr. Vasos’ claims. We can examine Dollar General’s financial numbers as seen on ycharts and see what they say.

There are some figures that justify Vasos’ confidence including slow but steady revenue growth. Dollar General’s revenues have increased every quarter since January 2013. There’s been none of the spectacular revenue growth we’ve seen at Amazon (NASDAQ: AMZN) or Dollar Tree (NASDAQ: DLTR) but no dramatic collapse like the one Target (NYSE: TGT) is dealing with.

Dollar General’s revenues grew by $150 million during third quarter 2016, rising from $21.01 billion in July to $21.26 billion in October. Although that growth has slowed a little, the company added $290 million in revenue during second quarter 2016, when it went from $20.72 billion in April to $21.01 billion in July.

The most likely cause for the discrepancy is the pace of new store openings. If that’s the case it points to a major problem at Dollar General – the company might be incapable of organic growth. That is it cannot add revenue in its existing footprint, the only way it can grow is to keep expanding.

That creates a danger because sooner or later Dollar General might hit the limits of expansion. Unlike Walmart (NYSE: WMT), Kroger (NYSE: KR) or Amazon it is not in a good position to add new businesses, or to try radical retail experiments. All three of those retail giants are experimenting with same day delivery and in-store pickup of online orders. Walmart is also engaged in a massive expansion of its ecommerce infrastructure that might be a direct threat to Dollar General.

Walmart’s Threat to Dollar General

Strangely enough Walmart is still the biggest threat to Dollar General, although it is far from the only one. The behemoth from Bentonville menaces Dollar General in three ways:

• Its’ Neighborhood Markets offer competitive prices and convenient shopping with greater selection and amenities DG cannot match, such as pharmacies and filling stations.

 

• Walmart’s online discounting is undercutting Dollar General’s prices and competing directly for rural customers. The recent acquisition of Jet.com gives Walmart even greater online discounting capabilities. Much of Dollar General’s success is in offering convenient local stores in small towns where there is no Walmart. Now Walmart can serve those customers without building a store. This should really worry DG investors because the National Retail Federation reported that more Americans shopped online than instore on Black Friday.

• Combining pickup of online orders with smaller formats gives Walmart the capability to quickly roll out hundreds new locations that offer great selection and small footprints. Walmart has opened two convenience stores where customers can pick up online orders that are pulled and packed at nearby Supercenters, Business Insider reported. This enables customers to fill their tank and pick up their order at the same time.

These trends should worry Dollar General because Walmart is going for the upper-income and middle-class customers dollar stores desperately need. To make matters worse Kroger and Amazon are engaged in similar experiments. Amazon is testing such a location in Seattle and Kroger is sure to follow.

A related threat is same day delivery which can be easily integrated with Walmart’s gas and go locations. Walmart is testing delivery options from both Lyft and Uber. If Walmart can roll out a cost-effective same-day delivery option it will capture the business of the soccer moms of America and drive dollar stores into the death spiral.

Is Dollar General Making Money?

Dollar General bulls might concede that all this is true; but say a lot of people still shop at dollar stores so they are still a good business and will be for years to come.

That might no longer be the case. Dollar General’s net income fell over the third quarter, ycharts reported. DG reported a net income of $1.231 billion in July that fell to $1.213 billion in October. The drop was small but it reverses about two years of income growth.

The drop might indicate that DG’s expansion costs are exceeding operating costs. A few quarters of falling revenue might force Vasos’ to put the brakes on the expansion. The drop also calls Dollar General’s 4.42% profit margin into question.

One big problem at Dollar General is that company appears to have very little float. It reported $200.24 million in cash and short-term investments and a free cash flow of $192.99 million on October 31, 2016. That indicates the financial resources to support the expansion might be there.

Why Dollar General Investors will get burned

A related problem might be the lack of assets, despite its’ size, Dollar General had assets of just $11.92 billion at the end of third quarter. Its resources are limited despite $1.693 billion in cash from operations.

My take is that Dollar General simply lacks the resources to sustain its growth. This company is slowly but surely headed for collapse making it a risky investment. When that collapse comes a lot of investors are going to get burned.

Many people have been buying DG because of the return on equity (22.56% on Halloween day 2016). Others are attracted by the dividend yield (1.3% on November 2, 2016). That did provide a dividend of 25¢ which is scheduled for a December 19 payout.

It should be noted that the DG dividend only goes back to April 22, 2015, which scares me. The current financial numbers indicate the company lacks the resources to support that dividend.

Stay away from Dollar General, its fast growth and limited resources put it in a dangerous position in a very competitive retail environment. Many investors are going to get burned by this stock in the near future.