Dollar General: -45% in FY23, +45% in FY24? (Part 1)
Dollar General: -45% in FY23, +45% in FY24? (Part 1)
The largest dollar store chain in America saw abysmal FY23 underperformance. We cover all of them in this report - and use objective data analysis to prove why many of those fears are unfounded.
Chapters
$DG Fundamental Analysis: Business Level, Store Unit Economics & ROIC (Part 2)
Financial Statement Analysis (Part 2)
Growth (Part 3)
Download Dollar General 3-Statement Model here! (paid subscribers only)
Click the Sections below to see our latest articles!
For our detailed analysis of Dollar General, check out Parts 2 and 3 of this report below!
Dollar General: Financial Background
We’ll start this report by providing a quick financial background of Dollar General; and then dive into the operational context of their recent ST underperformance. This will help you get up to speed with the current on-the-ground sentiment about DG 0.00%↑ — which we shall build on top to analyze the future trajectory of DG’s Operating Margins.
For the non-financial corporate history of how Dollar General started and grew to become the retail giant that it is today, please visit the following links: 1, 2, 3.
Largest dollar store chain in the USA, with 19,788 stores in the contiguous USA and 146,000 sqft of total selling space.
DG opened its first 2 stores in Mexico, with 14 more planned in 2024 as part of its long-term Mexico expansion plan.
They also started a new banner/chain concept called pOpshelf during the pandemic, which only sells higher margin non-consumable items. No. of pOpshelf stores in FY21: 55, FY22: 140, end-FY23: 215.
“If Walmart and 7-Eleven had a baby, that would be Dollar General” — David Perdue, former DG CEO and former US Senator of Georgia.
Lower-income customer demographic: DG primarily targets lower-income rural areas for store opening, and their CEO stated in their Q1 2023 earnings call that 80% of all DG stores are in rural communities with <20,000 people.
Most of Dollar Generals customers tend to have a household income of $40,000 or less, making them the most vulnerable customer demographic to higher inflation. However, management has recently observed trade-in trends from higher-income demographics of $75,000 - $100,000 looking to save money due to higher inflation.
For a good comparison of how DG’s competitive factors differs between Walmart vs. Dollar Tree, read this explanation. The short version is that DG stores are usually located much closer to rural communities than Walmart stores (30-40 minutes drive away) but price slightly higher than Walmart. Hence, marginal sales competition boils down to whether DG’s higher prices by 2-4% are worth the convenience of not having to drive to a Walmart. Dollar Tree doesn’t directly compete with DG despite also being a dollar store chain, since the former tends to skew towards higher-income urban locations.
The typical DG store is 7,300 sqft; however since the pandemic, management has pivoted towards larger store formats of 8,500 - 9,500 sqft (average: 7,400 sqft). These larger store formats enable a greater SKU variety (11,000-12,000 per store), taller retail shelf space, and large coolers for chilled consumables — and are ~5% of a typical Walmart’s size in terms of both selling sqft and SKUs. The expected end result from such investments is higher margins, which admittedly have yet to materialize.
Store COGS breakdown: The typical Dollar General store has 1 store manager, 1 assistant store manager, and 7-9 workers1. Each store has an expected cash payback period of less than 2 years. For every $100 in store sales, roughly $70 goes to COGS2:
$7 to employee salaries (average: $15k/year)
$5.60 to store leases (average: $110k/year)
$1.80 to other store operating expenses, e.g. utilities, insurance, maintenance & repairs.
$7 to HQ overheads.
Sales mix breakdown: As we can see in the chart below, Consumables represents the bulk of the Sales Mix (9M23: 81%) — and perhaps more importantly, Consumables have taken an increasing share of Net Sales over time, going from 74% in FY12 to 81% in FY23. This is a point of concern, since Consumables tend to be lower margin vs. Non-Consumables. DG’s new pOpshelf banner aims to address this, by focusing exclusively on sales of higher margin Non-Consumables.
Reasons Behind Recent ST Underperformance (-45% YTD)
DG’s abysmal -45% YTD underperformance was due to a confluence of factors, but it can all be boiled down into just one metric — Operating Margin compression. Both its top-line and bottom-line took a hit in FY23, and in this section we’ll explore all the contributing factors.
I want to give credit where credit is due — Gustywinds’ research on DG was incredibly helpful towards helping me understand why DG underperformed in the recent past. Please head over to his wonderful article to support him — I’ll be combining some of his takes alongside mine in the explanations below:
Cost Inflation: Both DG and its customer base have been among the hardest hit segments in the country by high inflation. As a dollar store business, DG competes on razor-thin margins and pays one of the lowest hourly wages, even amongst the minimum-wage retail sector3. This means that they are most exposed to cost inflation from a % increase perspective, due to the low base effect. Similarly, DG’s primary customer demographic tends to earn a household income of $40,000/yr, which is also the hardest-hit demographic by high inflation.
Lack of price Investments vs. peers: Price investment is just a fancy way of saying retail promotions. As mentioned above, competition in the space boils down to pricing vs. convenience relative to Walmart. In end-2022, CFO John Garatt mentioned that there was no need to invest in price in the context of preserving gross margins — given moderating supply chain costs and sales momentum from a then-recovering economy. However, Walmart and Family Dollar did end up implementing promotions throughout FY23, which led to DG’s comps (SSSG) declining by -1.3% in Q3 — as compared to +4.9% at Walmart and +2% at Family Dollar (i.e. market share losses). Dollar General did mention in its Q3 earnings call that they saw a turnaround in comp trajectory in November, which would be reflected in Q4 results.
SNAP roll-off: One of the largest components of “new money printed” during the pandemic was in the form of SNAP federal benefits (i.e. food vouchers). These disproportionately helped lower-income demographics, which subsequently gave Dollar General’s sales a huge boost during the pandemic. These SNAP benefits ended in Feb 2023, which subsequently reversed all the one-time sales gains it had made throughout the pandemic. SNAP contributions were estimated by sellside analysts to represent up to 10% of DG’s sales in FY22, and are not coming back (i.e. structural).
Labor and Shrink issues: Dollar General would have had one of the highest exposures to staff turnover amidst the Great Resignation of 2022, which disproportionately affected lower wage jobs. Amidst a hesitancy to match minimum wage hikes vs. peers (e.g. Walmart raised wages to $14/hr vs. DG’s $10+/hr), this resulted in DG stores reportedly being significantly understaffed, leading to higher incidences of theft and stocking issues which negatively impacted the customer experience.
So-called ‘smart teams’, the brainchild of former CEO Jeffery Owen (who left in Nov 2022), rotated staff between stores in the same region — presumably to reduce staff costs, but which led to a lack of oversight and increased self-checkout theft. The new CEO Todd Vasos has since gotten rid of smart teams in favor of increased labor investments to better the customer experience, a key retail selling point vs. peers.
DG also announced a $150M labor investment aimed at curtailing shrink issues and improving the customer experience (i.e. restocking, store cleanliness). However, some analysts are claiming even that might not be enough, as it only represents an additional 2 labor hours/day per store. ($14 hourly wage at 20,000 stores)
Inventory issues: One of the larger factors attributed to FY23 YTD underperformance was bloated inventory. To his credit, CEO Todd Vasos has been very transparent about the inventory issues DG faced in their Q3 earnings call, and mentioned how they were taking steps to address them.
Firstly, there was a huge restocking weakness in DG’s internal supply chain throughout FY22-23, where HQ faced supply chain bottlenecks — which resulted in some stores running out of stock of certain SKUs that were not restocked adequately (which could have driven customers to competitors). In response, management has allocated a $25M investment into a perpetual inventory system in 2024, which is expected to improve their inventory working capital position by $500M. Management has also indicated that they are already making substantial progress in reducing inventory so far in their Q3 earnings call (especially in non-consumables), and feel very good about further progress in 2024.
Higher inventory levels also contribute to higher shrink, so working through the inventory in 2024 should also contribute to lower shrink in 2024. Management has indicated that they they will materially rationalize SKU count, which should lead to improved efficiencies throughout the supply chain (examples below).
The supply chain issues which they faced in 2022 resulted in Dollar General exceeding its warehouse capacity constraints, and resorting to storing inventory in temporary outside warehouses to facilitate inventory flow. In response, DG is investing $480M into three additional distribution centers in Arkansas, Colorado and Oregon. Reducing base inventory levels should also help them reduce storage costs of leasing temporary outside warehouses in 2024.
Management has also indicated their goal within their supply chain is for truck deliveries to be on time and in full, or OTIF. “As we continue to drive our OTIF rates higher, we simplify the work for our store teams, which again results in a better overall experience for both our customers and associates as well as an expectation of higher sales (and lower unit costs).” — Q3 earnings call
“As our store teams have fewer SKUs to manage, we can lower our cost to serve, while driving higher inventory turns and higher sales of products that are most important to our customers.” — Q3 earnings call.
“So think about … as example, we may have five or six different variants of menace on the shelf today. We can easily drop one or two of those. The consumer is not going to know the difference, actually is going to make her life a little simpler when she goes to the shelf, going to make the store’s life simpler to put product on the shelf. And also, what it’s going to do is help our warehouses actually eliminate a lot of holding slots. So a lot of benefit to what we’re going to do in SKU rationalization.” — Q3 earnings call.
Weak retail macro: Finally, the first nine months of 2023 also saw wider general macro weakness and heightened economic uncertainty. This has more or less reversed in the last quarter of the year, with 1H24 looking to be more optimistic for the retail industry and unemployment rates at stable levels.
So is Dollar General a Value Trap… or Value Investing? In our follow-up Dollar General Part 2 and 3 reports, we will be doing a full deep-dive into Dollar General’s LT historical financial performance to assess their future performance trajectory, based on highly objective, data-driven analysis — the way management and LT investors might (in contrast to sellside). Click the links below if you’re curious to find out more!
For our detailed analysis of Dollar General, check out Parts 2 and 3 of this report below!
Click the Sections below to see our latest articles!
source: UBS
DG lumps all SG&A expenses together under a single line item, and doesn’t provide a breakdown between rental, employee salaries and sales/marketing expenses. The following COGS breakdown are estimates provided from general sources.
DG hourly wage of $10.87 vs. nationwide hardline/broadline and food retail average (ex-dollar stores) of $16.19. (source: UBS)
What an extensive article, Aaron! No wonder we haven’t had anything in our Inbox last week. Great work👏