Dollar General: A Boost to Investors and the IPO Market (DG)

Several high profile initial public offerings are scheduled for the next few weeks. One we’re watching with particular interest is Dollar General. A discount retailer, Dollar General is expected to sell 34 million shares between $21-$23 next Friday, November 13th. The stock will trade on the New York Stock Exchange under the ticker “DG.”

In theory, Dollar General shares should perform well in this weak economy. With nearly 9,000 locations in 35 states, the company is a favorite of cost-conscious consumers. Dollar General competes with stores like Walmart (WMT) and Kroger’s (KR) Fred Meyer subsidiary by offering both name-brand and generic items at reasonable prices. Selection ranges from groceries to home decor.

Dollar General targets households with a median income of less than $75,000 per year, making it a direct competitor to Walmart, but this competition doesn’t appear to be hampering Dollar General’s earnings power. In October, the company said its fiscal second quarter profit more than tripled thanks to better margins and an 8.6% surge in same-store sales. The company also plans to increase store openings and remodel certain locations. Oddly enough, Dollar General has no stores in California, the largest state by population.

That’s the good news; now, what could go wrong? First, with IPOs it is always a good idea to ask why the owners are cashing out. Private equity firm KKR and Goldman Sachs bought Dollar General in a leveraged buyout before the credit crisis unfolded, leaving the company saddled with more than $4.1 billion in debt. That’s an enormous sum under any circumstances.

The company expects to raise $750 million in the IPO. Nearly $478 million of those proceeds will be used to redeem debt. The company had a cash balance of $515 million at the end of July and paid a dividend of $239 million in September. (No word yet on whether Dollar General will pay a dividend upon going public.) It’s a cash cow so long as the debt load can be managed and eliminated.

Dollar General has had 20 consecutive years of same-store sales growth. Its stores are typically cash flow positive within a year of opening. Those are positive signs and could mean this discount retailer won’t trade at discount prices for very long. To buy into a Walmart alternative that targets cost-conscious consumers, go with Dollar General. You may not be able to buy at the IPO price, but the shares will be available to the public soon.