Underperforming Store Closures And Remodel Projects Will Shape Retail Future

Key Takeaways

• Store closures and declining customer traffic highlight challenges in urban markets, potentially impacting future growth and revenue.
  
• Rising expenses and price hikes to counter tariffs could strain core consumers, affecting margins amid inflationary pressures.
  
• Planned expansion and enhanced customer experience initiatives are expected to drive sales growth and improve operating margins for Dollar General.

Catalysts

About Dollar General

A discount retailer, provides various merchandise products in the southern, southwestern, midwestern, and eastern United States.

What are the underlying business or industry changes driving this perspective?

• Dollar General has decided to close 96 underperforming stores, many in urban locations, which indicates challenges in certain markets and could potentially dampen future revenue growth as these closures are expected to streamline resource allocation.
  
• Customer traffic declined by 1.1% in the quarter, highlighting the financial pressures on core consumers; with a continued macro environment pressure anticipated into 2025, this could impact future sales and revenue.
  
• The company plans to close an additional 45 underperforming pOpshelf stores, with only 6 being converted to Dollar General stores, indicating that pOpshelf may face strategic execution hurdles, which could lead to pressure on earnings and margin.
  
• To mitigate tariff impacts, Dollar General may need to potentially increase retail prices, affecting demand from its financially constrained core customers, which could compress future net margins amidst ongoing inflationary pressures.
  
• While shrink improvement is expected, SG&A costs are rising with increased labor expenses and expenses related to planned remodels in 2025; this SG&A pressure without corresponding sales growth can lead to deleveraging and affect operating margins.

Dollar General Future Earnings and Revenue Growth

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Dollar General compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Dollar General's revenue will grow by 3.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 3.9% today to 3.8% in 3 years time.
• The bearish analysts expect earnings to reach $1.8 billion (and earnings per share of $9.06) by about September 2029, up from $1.7 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $2.1 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 15.6x on those 2029 earnings, down from 16.6x today. This future PE is lower than the current PE for the US Consumer Retailing industry at 17.6x.
• The bearish analysts expect the number of shares outstanding to grow by 0.23% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.77%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Dollar General is poised for future growth as they plan to execute approximately 4,885 real estate projects in 2025, including 575 new store openings, which could boost net sales.
  
• Efforts to improve store productivity and customer experience, such as Project Elevate and Project Renovate, are expected to drive comp sales lifts and may help in boosting operating margins.
  
• Dollar General plans to expand its digital presence and delivery partnerships which, if successful, could lead to increased customer engagement and higher net sales.
  
• Improvements in inventory management are expected to continue, reducing working capital needs and potentially increasing operating margin effectiveness.
  
• The company is focusing on initiatives to grow the non-consumable product category, which could improve the gross margin mix by increasing the proportion of higher-margin products.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Dollar General is $103.36, which represents up to two standard deviations below the consensus price target of $138.93. This valuation is based on what can be assumed as the expectations of Dollar General's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $176.0, and the most bearish reporting a price target of just $90.0.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $48.6 billion, earnings will come to $1.8 billion, and it would be trading on a PE ratio of 15.6x, assuming you use a discount rate of 7.8%.
• Given the current share price of $127.87, the analyst price target of $103.36 is 23.7% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.