Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

The Death Spiral

Is Dollar General’s Price Over-inflated?

Investors could base Dollar General’s (DG) share price on exaggerated operating income and cash flow numbers. Moreover, the Dollar General Corporation (NYSE: DG) could have tens of millions of dollars in mortgages it cannot pay.

Those are the allegations commercial real-estate analyst John Flynn made to Intercept writers John Schwarz and Ryan Grim. Dollar General (DG) is the focus of Grim and Schwarz’s recent expose on commercial mortgage-backed securities (CMBS). Flynn was one of Grim and Schwarz’s principal sources for the article.

Flynn alleges several banks bundled commercial mortgages on dozens of Dollar General stores into CMBS’s that were sold to investors. In a Securities and Exchange Commission (SEC) complaint, Flynn claims analysts inflated Dollar General’s net operating income and net operating cash flow figures to make the CMBS more attractive investors.

Dollar General and Shadow Banks

The banks that Flynn names include Deutsche Bank (NYSE: DB) Wells Fargo (WFC), and Ladder Capital Corp(NYSE: LADR). Ladder Capital is a direct lender that Grim labels a “shadow bank.” Ladder’s speciality is commercial real estate financing solutions.

Shadow banks are unregulated alternative lenders who are not subject to the same regulation as bankers. Shadow bankers evade regulation by not offering insured accounts. Borrowers such as Dollar General use shadow banks because they can loan more fast.

Flynn claims to have found “about $150 billion in inflated CMBS” issued by Ladder, Deutsche Bank, and Wells Fargo. John W. Griffin and Alex Priest found similar problems when they when they examined 40,000 CMBS loans for a 2020 academic paper.

“Overall actual net operating income falls short of underwritten income by 5% or more in 28% of loans,” Griffin and Priest claim. The two also claim found a few banks “having more than 35% of their loans exhibiting 5% or greater income overstatement.”

Those banks are Ladder Capital (LADR), Citigroup (NYSE: C), Goldman Sachs (NYSE: GS), UBS (UBS), and Morgan Stanley (NYSE: MS), The Intercept claims. Griffin is a professor of finance at the McCombs School of Business at the University of Texas. Priest is a PhD candidate at the McCombs School of Business.

Grim and Schwarz focus on Dollar General (DG) because of a statement by Ladder President Pamela McCormack made in a 2020 earnings call. McCormack reputedly said, “our three largest tenants are Dollar General, BJ’s, and Walgreens (NASDAQ: WBA).”

Is it 2008 all over again?

There are some problems with The Intercept article. Grim and Schwarz portray Flynn as a heroic whistle blower, which is not true.

Flynn is taking no risks and could make money from his expose. Remember, Flynn will not lose his job or go to jail because of his “whistle blowing.”

In reality, Flynn is a financial analyst who makes his living offering opinions on stocks and real estate investment. Hence, Flynn could make more money and enhance his reputation through the article. In addition, Griffin and Priest are trying to cash in by offering their expertise.

I think the article itself contains poor writing and makes questionable claims. For example, comparing the current CMBS to the mortgage catastrophe of 2007-2008. Yes, there are similarities to the mortgage-backed derivatives of the early 21st Century. In both situations, they used questionable data to inflate mortgage.

I do not think a CMBS collapse will be as great as the 2008 meltdown. To explain, I suspect they confine the CMBS risk to one small area of the market, and could affect a few companies.

Conversely, a CMBS meltdown could harm some communities. Notably, Dollar General is the only general-merchandise retailer in many small towns and working-class neighborhoods. Thus, those communities could lose a vital retailer and tax revenue if Dollar General goes down.

How much Danger is Dollar General in?

Determining the level of CMBS risk is hard because they not reveal who is inflating the financial numbers. Is it somebody at Dollar General (DG), a banker or somebody else?

Yet these allegations will sound credible to anybody familiar with Dollar General’s business. I call Dollar General most dangerous stock in America for good reason. To elaborate, Dollar General operates in poor and depressed communities.

If you drive through a half-dead small town or a slum. Chances are Dollar General is one of the few national retailers you will see. I think Dollar General has a strategy of targeting poor neighborhoods and communities with no competition.

Unfortunately, the reason Dollar General lacks competition in those places is that other retailers think they cannot make money in those places. In fact, Dollar General opens in places where Walmart (WMT) fears to go. Moreover, I have to wonder how many of the inflated Dollar General mortgagees are on stores in slums, or depressed small towns.

Is Dollar General (DG) Making Money?

On the other hand, financial data shows Dollar General (NYSE: DG) is a growing and moneymaking company.

For instance, Dollar General’s quarterly revenues rose from $7.158 billion on 31 January 2020 to $8.415 billion on 31 January 2021. Similarly, Dollar General’s quarterly operating income grew from $720.88 million to $872.22 million in the same period.

Additionally, Dollar General’s quarterly gross profit grew from $2.273 billion to $2.737 billion between January 2020 and January 2021. Conversely, Dollar General’s quarterly operating cash flow fell from $576.89 million on 31 January 2020 to $492.62 million on 31 January 2021.

How Much Debt is Dollar General Paying?

Notably, Dollar General’s quarterly negative ending cash flow grew from -$35.76 million on 31 January 2020 to -$822.87 million on 31 January 2021. One reason the ending cash flow is so low is the enormous amount of debt Dollar General pays.

In fact, Dollar General reported a -$986.59 million quarterly financing flow on 31 January 2021. The quarterly operating flow grew from -$963.47 million on 31 October 2020 and -$670.79 million on 31 July 2020.

To explain, a negative quarterly financing cash flow is the amount of debt a company pays. A positive quarterly financing cash slow is the cash a company borrows. Dollar General reported a $905.86 million quarterly financing cash flow on 30 April 2020.

Dollar General (DG) finished 2020 with $13.590 billion total debts on 31 January 2021. The total debts rose from $11.696 billion on 31 January 2020.

Thus, Dollar General’s debt grew in 2020. Hence, I think investors need to worry about the allegations of CBMS related fraud at Dollar General.

Mr. Market overvalues Dollar General

I think Mr. Market overvalues Dollar General (NYSE: DG). There is nothing in DG’s financial numbers to support the $215.16 Mr. Market paid for Dollar General on 21 April 2021.

I conclude Dollar General is an overvalued stock that will collapse with or without CBMS fraud. Only time will tell if the expose on commercial mortgage-backed securities (CMBS) will be the scandal that crashes overpriced retail stocks such as Dollar General.