Dollar General Sale, Bad News Is Good News (DG, WMT, FDO, DLTR, NDN, KKR, GS)

This morning’s earnings from the king of dollar stores came in at $0.48 EPS as revenues rose 11% to $3.45 billion versus $0.50 EPS and $3.42 billion estimates from Thomson Reuters. Dollar General also reaffirmed guidance for its 2012 fiscal year of $2.20 to $2.30 EPS on revenue of roughly $14.5 billion to $14.7 billion.  The annual targets from Thomson Reuters are $2.26 EPS and $14.51 billion in sales.

Gross profits fell 63 basis points to 31.5% of sales, in part on rising commodity costs.  The company also noted that higher markdowns from winter merchandise and a sales mix shift to more consumable products helped to generate slightly lower gross margins.  Higher transportation costs were also cited, as was a slight inventory build.  Our take is that all of this should have been known and factored in by analysts, particularly as the company has continued adding stores.

What stands out is that Dollar General’s same-store sales grew by 5.4%.  The company noted that it kept prices lower to serve customers, but our take is that Dollar General will gradually raise prices.  Remember, the term “dollar store” now means very low prices rather than charging $1.00 for all merchandise.  The dollar store segment is today where Wal-Mart Stores Inc. (NYSE: WMT) was in the early 1990’s.  While we experienced the “reach-down” economy, dollar stores are also “reaching-up” to grab sales away from full-price retailers.  You cannot just go in a dollar store any longer and hassle the cashier by asking over and over how much each items costs since the answer is no longer $1.00.

One of the issues we see with Dollar General is that this drop might have come even if good news hit the tape.  Dollar General still has a large private equity overhang as both Kohlberg Kravis Roberts & Co. (NYSE: KKR) and Goldman Sachs Group Inc. (NYSE: GS) still hold millions of shares that will likely be sold off in the coming years.  At $35.00 our value flag alerts started to go off, not as massively overvalued but as getting closer to full value.  After all, Tuesday was the only day above $35.00 and the stock was under $30.00 as recently as mid-March.  Thomson Reuters even has a consensus price target of roughly $36.50.

Dollar General is more attractive now that shares are down.  That was our thesis when we called it a Stock for the Next Decade… Buy when the companies go on sale.  At $2.26 EPS expected this year, it trades at 14.3-times expected earnings.  That was 15.5-times expected earnings just yesterday.  Analysts have been surprised many times by how well the dollar stores have done and it keeps happening that analysts expect too much.  We still think that this will be a $40.00 by the end of 2012.  We have not even seen word of a dividend as of yet, something we expect to change in the coming year.

Dollar General Corporation (NYSE: DG) is down 7.5% at $32.43 right after 2:00 PM EST on more than 5.6 million shares.  The 52-week range is $26.61 to $35.09 and average volume is roughly 1.4 million shares.

Wal-Mart Stores Inc. (NYSE: WMT) is down 1.4% at $54.45, Family Dollar Stores Inc. (NYSE: FDO) is down 1.7% at $54.79, Dollar Tree, Inc. (NASDAQ: DLTR) is down 1.6% at $62.72, and 99 Cents Only Stores (NYSE: NDN) is down $0.01 at $20.65.

Any time you see a large pullback, you never want to jump all in at once.  Big drops are usually followed by additional drops.  Be patient, but remember that the stars are still properly aligned for the dollar store segment.  Sometimes a gift is a gift, particularly if you are a value investor.  Stay tuned.

JON C. OGG