By Andrew Bary

Dollar General is seeking to restore its standing with investors after a tough few years for the company and its shares. The stock now looks like a bargain.

The leader in the "dollar store" market certainly has fallen on hard times. Its stock has dropped 70% since a 2022 high, and its earnings have been cut in half over the same period. Shares have been hammered over the past six months as Dollar General's two most recent earnings releases have fallen short of estimates. Wall Street, meanwhile, is skeptical that the former retailing favorite can fend off Walmart and others catering to low-income shoppers.

That view may be too pessimistic. The company has a depressed stock, depressed earnings, a solid balance sheet, and a well-defined position in rural areas that no other retailer can match. It has a CEO in Todd Vasos who has a plan to improve performance, including store remodels, judicious expansion, and initiatives to cut shoplifting. The shares also yield 3.3%, and the dividend is well covered by earnings.

"Very little has to go right for sentiment to improve," says John Rogers, a senior research analyst at Pzena Investment Management. "It's a good business in a clearly defined niche."

Dollar General's turnaround starts from an enviable position. The company has an entrenched position as the general grocer to rural America. With more than 20,000 stores -- including 1,800 in Texas alone and about 1,000 in seven other states, including Florida -- it has the largest store footprint of any retailer. About 80% serve communities of fewer than 20,000 people.

The golden age for the company was from 2020 through 2022, when government stimulus payments boosted low-income customers and the company earned over $10 a share with margins of about 9%. At its 2022 peak, Dollar General had a similar valuation to Walmart. The two stocks have diverged sharply since then, as Walmart shares doubled and now trade for 35 times estimated 2025 earnings. Dollar General, with a $16 billion market value, fetches less than 13 times.

That seems too pessimistic -- especially if Dollar General can turn itself around. Brian Yarbrough, an analyst at Edward Jones, believes it can. "We don't believe it's structural and that the Dollar General business model is broken" he says.

But it does have a lot of work to do. Yarbrough thinks Dollar General's pretax operating profit margin, now around 5%, can get back to the 6%-to-6.5% range, potentially resulting in about $8 a share in earnings in 2027. That could result in a stock price above $100. Analysts expect 3% growth, to $5.90 a share in earnings, in 2025. Yarbrough also argues that Dollar General needs to generate same-store sales growth of 2% to 4% -- above the 1% in the most recent quarter -- to help boost sentiment.

Dollar General has many ways to help boost its margins. Among the positive trends is lower "shrink," or losses to shoplifting and employee theft. Shrink improved in the latest quarter after cutting margins by an estimated percentage point since 2019 the company scaled back its use of self-checkout.

Dollar General also knows its customer base -- one unfamiliar to most Wall Street analysts and investors. The company gets 60% of its sales from customers who have household incomes of $30,000 or less.

"We're probably the closest to that low-end consumer of any retailer out there," Vasos reminded investors at a Goldman Sachs conference in September.

Basic consumables -- milk, eggs, cereal, paper towels, snacks -- account for about 80% of sales. The average ticket size is in the $15 to $20 range, and many customers come with envelopes of cash. Sales often fade by month end, as customers run low on money.

Dollar General does have a Walmart problem. Its stores have a small-box format with about 8,000 square feet, against Walmart supercenters at 175,000 square feet. They're closer to 7-Elevens than fully stocked grocery stores. One concern is that Walmart's various initiatives -- such as e-commerce and curbside pickups -- pose more of a threat.

But just because Walmart is successful doesn't mean Dollar General can't succeed, as well. Dollar General offers weekly specials like grocers do -- including one this past week for three boxes of Kellogg's cereal for $7. It aims to keep prices within 5% of Walmart's, says Pzena's Rogers. "The playbook is to coexist with Walmart and take share from full-line grocery stores and the front end of drugstores," he says.

Dollar General views convenience as a selling point, given that it can be 10 miles or more to the nearest Walmart. That can mean $3 to $4 in gasoline expenses, not trivial on small orders. Vasos also cites a surprising reason why its shoppers prefer Dollar General: Customers tell the company they "don't want the distraction of going to a big-box store and be tempted to buy other stuff."

And there really is no other company quite like Dollar General. Its closest rival, the Dollar Tree--owned Family Dollar, is less profitable; Barron's Roundtable member Meryl Witmer recently said it should be sold. Family Dollar operates more in urban areas, where labor costs are higher, shoplifting can be more problematic, and shoppers often have more options.

There is also considerable room for Dollar General to expand. It isn't currently buying back its shares, as the company emphasizes new store openings and remodels of existing ones. Vasos has said it sees "significant opportunities for growth" for about 12,000 new stores in the U.S., though the company has scaled back its growth. It planned to open 730 stores in the just-completed fiscal year and 575 in the coming year, down from about 1,000 in 2023. Many of the stores could benefit from makeovers, and the company plans a full remodel of 2,000 stores in the coming year.

Vasos says Dollar General is capable of getting back to low-double-digit annual earnings growth, although he won't commit to when. Nothing like double-digit growth is now discounted in the stock. It might not take much improvement to get investors excited again about it.

Write to Andrew Bary at andrew.bary@barrons.com

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January 31, 2025 12:09 ET (17:09 GMT)

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