Discount retailer Dollar General (NYSE:DG) fell short of analysts' expectations in Q2 FY2023, with revenue up 3.93% year on year to $9.8 billion. The company didn’t provide any forward revenue guidance. Turning to EPS, Dollar General made a GAAP profit of $2.13 per share, down from its profit of $2.98 per share in the same quarter last year.
Dollar General (DG) Q2 FY2023 Highlights:
- Revenue: $9.8 billion vs analyst estimates of $9.91 billion (1.15% miss)
- EPS: $2.13 vs analyst expectations of $2.47 (13.7% miss)
- Free Cash Flow of $130.8 million, similar to the same quarter last year
- Gross Margin (GAAP): 31.1%, down from 32.3% in the same quarter last year
- Same-Store Sales were down 0.1% year on year (miss vs. expectations of up 0.7% year on year)
- Store Locations: 19,488 at quarter end, increasing by 922 over the last 12 months
Appealing to the budget-conscious consumer, Dollar General (NYSE:DG) is a discount retailer that sells a wide range of household essentials, groceries, apparel/beauty products, and seasonal merchandise.
Founded in 1939 and originally called J.L. Turner & Son, the company changed its name to Dollar General in 1968. The core Dollar general customer is typically a lower-income household in underserved rural or suburban areas. Perhaps that area is not served well by large regional grocery stores or general merchandise retailers such as Walmart, which is where Dollar General sees opportunity.
Dollar General tends to sell smaller unit quantities for those who cannot afford to buy in bulk and want to instead buy for immediate need. For example, you might not be able to buy a pack of one or two paper towel rolls at Kroger or Costco, but Dollar General has you covered here.
The Dollar General store is generally less than 10,000 square feet, much smaller than traditional grocery stores or general merchandise giants such as Walmart and Costco. These Dollar General stores feature easy-to-navigate layouts. Because of smaller store sizes, there is usually less selection within categories (only two ketchup brands, for example) and fewer store employees. Dollar General sells a combination of national brands as well as private label products, but again, the selection of brands is limited.
Traditional grocery stores are go-tos for many families, but discount grocers serve those who may not have a traditional grocery store nearby or who may have different spending thresholds. Certain rural or lower-income areas simply don’t have a grocery store. Additionally, some lower-income families would prefer to buy in smaller quantities than available at most stores (think one or two paper towel rolls at a time). While online competition threatens all of retail, grocery is one of the least penetrated because of the nature of buying food. Furthermore, those buying small quantities for immediate need are even less likely to leverage e-commerce for these purposes.
Competitors that sell general merchandise and/or groceries to US consumers include Walmart (NYSE:WMT), Costco (NYSE:COST), and Kroger (NYSE:KR).Sales Growth
Dollar General is one of the larger companies in the consumer retail industry and benefits from economies of scale, enabling it to gain more leverage on fixed costs and offer consumers lower prices.
As you can see below, the company's annualized revenue growth rate of 9.83% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was decent as it opened new stores and grew sales at existing, established stores.
This quarter, Dollar General grew its revenue by 3.93% year on year, falling short of Wall Street's estimates. Looking ahead, the analysts covering the company expect sales to grow 4.64% over the next 12 months.
Number of Stores
The number of stores a retailer operates is a major determinant of how much it can sell, and its growth is a critical driver of how quickly company-level sales can grow.
When a retailer like Dollar General is opening new stores, it usually means that demand is greater than supply, and in turn, it's investing for growth. Since last year, Dollar General's store count increased by 922 locations, or 4.97%, to 19,488 total retail locations in the most recently reported quarter.
Over the last two years, the company has opened new stores quickly and averaged 5.24% annual growth in new locations, meaningfully higher than other consumer retail businesses. With an expanding store base and demand, revenue growth can come from multiple vectors: sales from new stores, sales from e-commerce, or increased foot traffic and higher sales per customer at existing stores.
Same-Store Sales
A company's same-store sales growth shows the year-on-year change in sales for its brick-and-mortar stores that have been open for at least a year, give or take, and e-commerce platform. This is a key performance indicator for retailers because it measures organic growth and demand.
Dollar General's demand within its existing stores has generally risen over the last two years but lagged behind the broader consumer retail sector. On average, the company's same-store sales have grown by 2.62% year on year. With positive same-store sales growth amid an increasing physical footprint of stores, Dollar General is reaching more customers and growing sales.
In the latest quarter, Dollar General's same-store sales fell 0.1% year on year. This decline was a reversal from the 4.6% year-on-year increase it posted 12 months ago. A one quarter hiccup isn't material for the long-term prospects of a business, but we'll keep a close eye on the company.
Gross Margin & Pricing Power
Gross profit margins tell us how much money a retailer gets to keep after paying for the goods it sells.
As you can see below, Dollar General has averaged a weak 31.2% gross margin over the last eight quarters. However, when comparing its margin specifically to other non-discretionary retailers, it's actually pretty solid. That's because non-discretionary retailers have structurally lower gross margins as they compete to provide the lowest possible price, sell products easily found elsewhere, and have high transportation costs to move their goods. We believe the best metrics to assess these types of companies are free cash flow margin, operating leverage, and profit volatility, which take their scale advantages and non-cyclical demand characteristics into account. 
Dollar General produced a 31.1% gross profit margin in Q2, marking a 1.3 percentage point decrease from 32.3% in the same quarter last year. This drop raises an eyebrow for a retailer like Dollar General, which is structurally less profitable than the typical retail business for the reasons mentioned above, as it could signal a more competitive environment with higher input costs (such as distribution expenses to move goods) and more pressure to discount its products.
Operating Margin
Operating margin is an important measure of profitability for retailers as it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.
In Q2, Dollar General generated an operating profit margin of 7.07%, down 2.6 percentage points year on year. We can infer that Dollar General was less efficient with its expenses or had lower leverage on its fixed costs because its operating margin decreased more than its gross margin.
From an operational perspective, Dollar General has done a decent job over the last eight quarters. The company has produced an average operating margin of 8.4%, higher than the broader consumer retail sector. On top of that, its margin has remained more or less the same, highlighting the consistency of its business. The company's profitability was particularly impressive because of its low gross margin. This margin is mostly a factor of what Dollar General sells and it takes tectonic shifts to move meaningfully. Companies have more control over their operating margins, and it signals strength if they're high when gross margins are low (like for Dollar General).EPS
Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.
In Q2, Dollar General reported EPS at $2.13, down from $2.98 in the same quarter a year ago. This print unfortunately missed Wall Street's estimates, but we care more about long-range EPS growth rather than short-term movements.
Between FY2020 and FY2023, Dollar General's adjusted diluted EPS grew 5.93%, translating into an unimpressive 1.98% average annual growth rate.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills.
Dollar General's free cash flow came in at $130.8 million in Q2, up 7.85% year on year. This result represents a 1.34% margin, in line with its free cash flow margin in the same period last year.
Over the last eight quarters, Dollar General has shown mediocre cash profitability, putting it in a pinch as it gives the company limited opportunities to invest organically into its business, pay down debt, or return capital to shareholders. Its free cash flow margin has averaged 1.95%, subpar for a consumer retail business. Furthermore, its margin has averaged year-on-year declines of 3.5 percentage points. Although we'd rather see free cash flow conversion increase, short-term fluctuations like this aren't a big deal.
Return on Invested Capital (ROIC)
Dollar General's subpar returns on capital may signal a need for future capital raising or borrowing to fund growth. Its five-year average return on invested capital (ROIC) is 12%, somewhat low compared to the best retail companies that consistently pump out 25%+ returns.
We argue ROIC is one of the most important indicators of quality because it tells us how much return (profit) a company makes on the money it invests into its business, shedding light on its prospects and its management team's decision-making prowess. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from Dollar General's Q2 Results
Sporting a market capitalization of $34.6 billion, more than $353 million in cash on hand, and positive free cash flow over the last 12 months, we believe that Dollar General is attractively positioned to invest in growth.
We struggled to find many strong positives in these results. Both its revenue and EPS unfortunately missed analysts' expectations. Gross and operating margins declined year on year. Additionally, the company lowered full year guidance across the board, with a particularly jarring reduction in EPS outlook. Management acknowledged this, saying “While we are not satisfied with our overall financial results, we made significant progress in the second quarter improving execution in our supply chain and our stores, as well as reducing our inventory growth rate and further strengthening our price position." Overall, this was a mediocre quarter for Dollar General. The company is down 14.4% on the results and currently trades at $135.06 per share.
Is Now The Time?
When considering an investment in Dollar General, investors should take into account its valuation and business qualities as well as what happened in the latest quarter. We cheer for everyone who's improving the lives of others but in the case of Dollar General, we'll be cheering from the sidelines. Its revenue growth has been a little slower, and analysts expect growth rates to deteriorate from there. And while its stable growth in physical locations shows that it has steady demand, the downside is that its mediocre same-store sales performance has stunted total revenue growth and its gross margins make it more difficult to reach positive operating profits compared to other consumer retail businesses.
While it's trading at a reasonable price and we've no doubt one can find things to like about Dollar General, at the moment, we think there might be better opportunities in the market.
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