How Far Can A Dollar (General) Go These Days?

Warren Buffett certainly knows a good thing when he sees it. When Buffett, 81, announced earlier in the month he had a position in Dollar General DG, many thought it was a shrew move. After today's earnings beat, it looks like an even shrewder move. The Goodlettsville, Tennessee-based company reported second quarter earnings which beat Wall Street estimates, and also raised its full year outlook. Dollar General reported earnings of 52 cents per share on $3.58 billion in revenues. Wall Street had been expecting earnings of 48 cents per share on $3.54 billion in revenues. It also raised the lower end of its 2012 guidance, going from $2.20-$2.30 per share, to $2.22-$2.30 per share. It also said that it sees sales up 12-14% in 2012. “Dollar General delivered strong results for the second quarter,” said Rick Dreiling, chairman and chief executive officer. “Our same-store sales increase of 5.9 percent in the quarter represents an acceleration from the first quarter and demonstrates our ability to balance the challenges of pricing and rising input costs. Our customers are depending on us even more for the convenience and value we offer. “In this period of economic uncertainty, we continue to focus on factors that we can control, and we still expect to deliver strong financial performance in 2011,” Dreiling continued. “Given our results in the first half of the year, we are raising the low-end of our earnings guidance range reflecting expected same-store sales growth of 4 to 6 percent. For the 53-week fiscal year, we now expect total sales growth of 12 to 14 percent and adjusted EPS of $2.22 to $2.30.” Dollar General said that same-store-sales rose 5.9 percent during the quarter, a faster pace than the first quarter's 5.4 percent rise. The company also said that gross margins fell less than the first quarter. Gross margins were at 32.1% during the quarter, compared to 32.2% a year ago. "I saw a lot of encouraging signs in the results," said BB&T Capital Markets analyst Anthony Chukumba in quotes obtained by Reuters. Chukumba went on to say, "The second half of this year is setting up quite nicely for Dollar General. The U.S. macroeconomic environment remains challenging, so we should see a continuation of the trade down phenomenon where consumers are trading down to Dollar General from higher-priced alternatives such as supermarkets, convenience stores and drugstores." He has a Buy rating on shares. The dollar store sector has seen a lot of interest recently, from Family Dollar FDO to 99 Cents Only Stores NDN to Dollar Tree DLTR. Big names like Bill Ackman, Nelson Peltz, Leonard Green & Co. and now Buffett are all moving heavily into the space. As the U.S. economy looks to be heading into another recession, these stores, which generally sell most of their merchandise for $10 and under, are expected to do far better than big box stores like Wal-Mart WMT. This is due to the close proximity to shoppers' homes, as well as affordability of certain goods. After today's ~3% pop, shares are still reasonably valued, using 2012 earnings estimates. Using the low end of 2012 earnings estimates, shares trade at 15.8 times 2012 earnings. This is fairly cheap for a company that expects to grow its sales at a 12-14% clip over the next fiscal year. The company does not pay a dividend, unlike some of its competitors. At the Ira Sohn Investment Conference in May, Pershing Square's Ackman was very complimentary of Dollar General, the acknowledged leader in the space. After the company came back to the public markets in November 2009, it has been operating better and more efficiently than its competitors. Dollar General is still majority-owned by private equity firm Kohlberg Kravis Roberts & Co LP. Ackman said that Dollar General has higher margins, sales per square foot, and faster growth. The company has also increased the hours its stores are open. What Ackman saw back in May is precisely what Buffett sees as well. Dollar General is operating on all cylinders, and as the economy continues to stay weak, this space should continue outperform in the long run. Seems as if a Dollar (General) can go along way these days. ITEMS:

Bullish:
Traders who believe that the dollar store space will continue to outperform might want to consider the following trades:

• Consider any of the dollar stores. Dollar General is operating the most efficient, but Ackman believes Family Dollar is significantly undervalued. Also look at Dollar Tree, and 99 Cents Only Stores as well.

Bearish:
Traders who believe that the dollar stores will eat away at Wal-Mart's market share may consider alternate positions:

• Dollar stores have a competitive advantage because of their smaller size and closer proximity to key demographics. Wal-Mart is trying to compete with Wal-Mart Express, but it could fall short in its effort. Consider shorting Wal-Mart on this.
  
  

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