Many shall be restored that now are fallen and many shall fall that now are in honor. – Horace, Ars Poetica (epigraph to Ben Graham’s Security Analysis) Dollar General, one of the market’s COVID darlings, has fallen from grace. The stock is down over 50% from its all time high, its largest drawdown ever, and currently trades at its March 2020 COVID lows.
I go into DG frequently and avoid Crazy-Mart like the plague. I’m not seeing how the DG customer will be going to WMT more frequently now than she was in the past. The argument that a DG shopper transforms into a WMT shopper when money becomes extremely tight doesn’t hold water for me---money is always extremely tight for the DG shopper.
I think there’s a habitual component to DG shopping or maybe people are too lazy to drive all the way to Crazy-Mart. Plus, People in the DG stores seem to know each other-- the clerk is carrying on various conversations and calling customers by name. And, the basket size is so much smaller at DG that WMT doesn’t seem to be a substitute. Finally, when money gets tighter, some CVS, WAG, KR shoppers may head over to DG.
Brookfield Corporation, Dollar General, and Ally Financial would probably be my top picks in terms of the best value I'm seeing right now. Although, it will be interesting to see how well this comment ages :)
There are a lot data-backed accusations that in the last 12-24 months DG price increases have outpaced WMT, and now the same basket of goods can cost ~10% more at DG vs. nearest WMT (according to Morgan Stanley's work). If true, then rural target customers are now more justified in driving further to go to WMT. Not sure how DG can overcome this.
I have seen those claims and cited them in my article. I do think that price discrepancies are a big reason they're losing traffic. When money is extremely tight people will absolutely drive 20-30 minutes to save 10%. However, I don't see why DG can't get back to parity with Walmart. They've done it before and can surely do it again. They likely only need to do it on a few key items which are frequently purchased and have easily noticeable and comparable prices. The key to investing in DG is believing that they're the low-cost producer (or very close to it). If so, they'll close the gap, If not, they'll continue having problems.
"Low cost producer." I've only seen you establish this claim about G&A. However, cost advantage (or disadvantage) can show up on COGS too. Who cares if DG has the most efficient G&A if they're increasingly failing to manage COGS? If DG's price premium over WMT is driven by inability to control COGS (which is the most probably reason, imo) then I see no reason or argument on your part to assume that it's an inevitability and a mere matter of time until DG gets this under control. What if their COGS took an irreversible step change?
By the way, I'm not trying to be adversarial. I'd like to be proven wrong on this one, the thesis is just not clear to me.
Mr. Lenity, thanks for the thoughtful comment. I always appreciate intelligent feedback.
I agree that a low cost producer needs to have competitive COGS. There isn't granular enough data available to know exactly what DG's COGS are vs WMT's for a particular SKU, but we can infer that they're close to parity.
One reason WMT's COGS aren't directly comparable to DG's is mix. WMT sells a much broader array of goods than DG (140,000 SKUs vs 10,000). That's especially true within WMT's grocery department. Perishable foods, particularly fresh foods, have lower margins than center-of-the-store non-perishables. DG specializes in non-perishable consumables which explains at least some of its gross margin advantage over WMT. It also explains some of DG's lower SG&A since non-perishables require less labor and simpler supply chains (e.g. no cold storage).
One method is to compare sales per SKU at DG and WMT. If sales per SKU are similar we can infer that both companies possess similar bargaining power with their suppliers and therefore have similar COGS.
WMT US's grocery department had LTM sales of $247,299 million. WMT typically carries 140,000 SKUs and 59% of last year's sales were grocery. We can estimate that WMT US carries at least 82,600 SKUs (59% of 140,000) and that WMT US Grocery sells about $3.0 million per SKU.
WMT's grocery department probably stocks more SKUs than the rest of the store, so this estimate may skew high.
However, we'd really want to know about sales per supplier, not sales per SKU. DG might stock Coca-Cola in one side (say 2L bottles) while WMT may sell 2L bottles, 12-pack cans, and many other sizes. Each of these sizes are a different SKU but all aggregate towards WMT's bargaining power with Coca-Cola.
DG's LTM sales are $38,806 million and it carries 10,000 SKUs. That's $3.9 million of sales per SKU. 80% of DG's mix is non-consumables so taking 80% of this number or $3.1 million, is most comparable with the WMT US Grocery number.
WMT's sales per SKU of $3.0 million is slightly below DG's $3.1 million. There are estimates but show roughly equal bargaining power with suppliers which implies similar COGS.
I established in my original article that DG has an advantage in SG&A overhead versus WMT. Therefore I think it's credible to conclude that DG could once again achieve parity with WMT's prices.
I don't believe DG needs to achieve parity on every item with WMT. A significant piece of DG's value proposition is convenience. That's worth something to DG's customers because driving isn't free (time, gas, depreciation). DG needs to be within a few percent of WMT on key items in order to earn loyalty and traffic.
While I cannot provide an iron-clad argument for why DG is a low-cost producer, I hope this helps explain my thinking.
Would Costco be more applicable as lowest cost producer given their EDLC policy? I know they are different shoppers/consumer segment but could this eventually be a risk?
Costco is definitely a lower-cost producer than DG but they're different businesses catering to different people. In my original 2021 piece I called DG an anti-Costco because DG's customers want smaller size SKUs that are cheaper. They buy them with greater frequency to match their budget and timing of paydays. Costco's shoppers have sufficient cash on hand to stock up and reap the savings. Costco customers shop less frequently as a result.
1. Normalized earnings (the pandemic boom in retail sales for all retailers hadn't deflated yet last time I checked)
2. A 16x multiple assumes that 5 years from now the company will have a good remaining growth runway. I hear the US is getting really saturated. (In this respect it's really interesting you mentioned Mexico!)
Thanks Frederik. Those are all valid concerns I'll be keeping an eye on.
On point 1 I don't think DG's sales will fully retrace their pandemic book because of price per SKU inflation. But some of DG's current pain is surely because of a normalization and it's hard to say where that normalization will end.
On point 2 I agree that they'll need to continue to find a source of growth to deserve that multiple. Our approach is to look for situation where a re-rating is possible but to treat it purely as a bonus. We want satisfactory returns if we only earn the yield and growth (what we call the "business" return).
On point 3 I need to do (a lot) more work but having spent a lot of time on a typical DG market (< 20,000 people, $40k/household incomes) I don't think it's been a factor (yet).
Thanks for sharing your thoughts, Matt. Point 3 might be one of those things that are really hard to predict, and a high margin of safety might be the answer.
I also wanted to say I find it a real privilege to be able to read this quality of analysis. Loved your post on Eurofins!
I go into DG frequently and avoid Crazy-Mart like the plague. I’m not seeing how the DG customer will be going to WMT more frequently now than she was in the past. The argument that a DG shopper transforms into a WMT shopper when money becomes extremely tight doesn’t hold water for me---money is always extremely tight for the DG shopper.
I think there’s a habitual component to DG shopping or maybe people are too lazy to drive all the way to Crazy-Mart. Plus, People in the DG stores seem to know each other-- the clerk is carrying on various conversations and calling customers by name. And, the basket size is so much smaller at DG that WMT doesn’t seem to be a substitute. Finally, when money gets tighter, some CVS, WAG, KR shoppers may head over to DG.
Basically, DG just seems to be going through a COVID hangover...
Brookfield Corporation, Dollar General, and Ally Financial would probably be my top picks in terms of the best value I'm seeing right now. Although, it will be interesting to see how well this comment ages :)
There are a lot data-backed accusations that in the last 12-24 months DG price increases have outpaced WMT, and now the same basket of goods can cost ~10% more at DG vs. nearest WMT (according to Morgan Stanley's work). If true, then rural target customers are now more justified in driving further to go to WMT. Not sure how DG can overcome this.
I have seen those claims and cited them in my article. I do think that price discrepancies are a big reason they're losing traffic. When money is extremely tight people will absolutely drive 20-30 minutes to save 10%. However, I don't see why DG can't get back to parity with Walmart. They've done it before and can surely do it again. They likely only need to do it on a few key items which are frequently purchased and have easily noticeable and comparable prices. The key to investing in DG is believing that they're the low-cost producer (or very close to it). If so, they'll close the gap, If not, they'll continue having problems.
"Low cost producer." I've only seen you establish this claim about G&A. However, cost advantage (or disadvantage) can show up on COGS too. Who cares if DG has the most efficient G&A if they're increasingly failing to manage COGS? If DG's price premium over WMT is driven by inability to control COGS (which is the most probably reason, imo) then I see no reason or argument on your part to assume that it's an inevitability and a mere matter of time until DG gets this under control. What if their COGS took an irreversible step change?
By the way, I'm not trying to be adversarial. I'd like to be proven wrong on this one, the thesis is just not clear to me.
Mr. Lenity, thanks for the thoughtful comment. I always appreciate intelligent feedback.
I agree that a low cost producer needs to have competitive COGS. There isn't granular enough data available to know exactly what DG's COGS are vs WMT's for a particular SKU, but we can infer that they're close to parity.
One reason WMT's COGS aren't directly comparable to DG's is mix. WMT sells a much broader array of goods than DG (140,000 SKUs vs 10,000). That's especially true within WMT's grocery department. Perishable foods, particularly fresh foods, have lower margins than center-of-the-store non-perishables. DG specializes in non-perishable consumables which explains at least some of its gross margin advantage over WMT. It also explains some of DG's lower SG&A since non-perishables require less labor and simpler supply chains (e.g. no cold storage).
One method is to compare sales per SKU at DG and WMT. If sales per SKU are similar we can infer that both companies possess similar bargaining power with their suppliers and therefore have similar COGS.
WMT US's grocery department had LTM sales of $247,299 million. WMT typically carries 140,000 SKUs and 59% of last year's sales were grocery. We can estimate that WMT US carries at least 82,600 SKUs (59% of 140,000) and that WMT US Grocery sells about $3.0 million per SKU.
WMT's grocery department probably stocks more SKUs than the rest of the store, so this estimate may skew high.
However, we'd really want to know about sales per supplier, not sales per SKU. DG might stock Coca-Cola in one side (say 2L bottles) while WMT may sell 2L bottles, 12-pack cans, and many other sizes. Each of these sizes are a different SKU but all aggregate towards WMT's bargaining power with Coca-Cola.
DG's LTM sales are $38,806 million and it carries 10,000 SKUs. That's $3.9 million of sales per SKU. 80% of DG's mix is non-consumables so taking 80% of this number or $3.1 million, is most comparable with the WMT US Grocery number.
WMT's sales per SKU of $3.0 million is slightly below DG's $3.1 million. There are estimates but show roughly equal bargaining power with suppliers which implies similar COGS.
I established in my original article that DG has an advantage in SG&A overhead versus WMT. Therefore I think it's credible to conclude that DG could once again achieve parity with WMT's prices.
I don't believe DG needs to achieve parity on every item with WMT. A significant piece of DG's value proposition is convenience. That's worth something to DG's customers because driving isn't free (time, gas, depreciation). DG needs to be within a few percent of WMT on key items in order to earn loyalty and traffic.
While I cannot provide an iron-clad argument for why DG is a low-cost producer, I hope this helps explain my thinking.
Would Costco be more applicable as lowest cost producer given their EDLC policy? I know they are different shoppers/consumer segment but could this eventually be a risk?
Costco is definitely a lower-cost producer than DG but they're different businesses catering to different people. In my original 2021 piece I called DG an anti-Costco because DG's customers want smaller size SKUs that are cheaper. They buy them with greater frequency to match their budget and timing of paydays. Costco's shoppers have sufficient cash on hand to stock up and reap the savings. Costco customers shop less frequently as a result.
Absolutely great writeup!
My concerns are:
1. Normalized earnings (the pandemic boom in retail sales for all retailers hadn't deflated yet last time I checked)
2. A 16x multiple assumes that 5 years from now the company will have a good remaining growth runway. I hear the US is getting really saturated. (In this respect it's really interesting you mentioned Mexico!)
3. Temu
Thanks Frederik. Those are all valid concerns I'll be keeping an eye on.
On point 1 I don't think DG's sales will fully retrace their pandemic book because of price per SKU inflation. But some of DG's current pain is surely because of a normalization and it's hard to say where that normalization will end.
On point 2 I agree that they'll need to continue to find a source of growth to deserve that multiple. Our approach is to look for situation where a re-rating is possible but to treat it purely as a bonus. We want satisfactory returns if we only earn the yield and growth (what we call the "business" return).
On point 3 I need to do (a lot) more work but having spent a lot of time on a typical DG market (< 20,000 people, $40k/household incomes) I don't think it's been a factor (yet).
Thanks for sharing your thoughts, Matt. Point 3 might be one of those things that are really hard to predict, and a high margin of safety might be the answer.
I also wanted to say I find it a real privilege to be able to read this quality of analysis. Loved your post on Eurofins!
I agree, the valuation is the critical piece to weight against the uncertainty. Thanks for the kind words and for reading.
Really enjoyed this analysis, thanks Matt!
Thanks Bob!
Second it
Thanks Aaron!
DG are popping up in every small town. Newest one going up in Walnut Springs, Tx.. Glen Rose,Morgan,Lakeside Village.