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Dollar Stores Still Going Strong

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Discount retailers were some of the few beneficiaries of the financial crisis, as cash-strapped consumers were forced to cut back on spending. With the economy and jobs pictures now improving, one would think that this growth would slow, and to some degree this is the case. Yet while they're no longer posting double-digit growth, dollar stores still seem to be doing well. Not valued too expensively at the moment, Dollar General (NYSE: DG  ) in particular seems like a good bet in the industry.

Introducing Dollar General
Dollar General is America's largest dollar store chain by market cap, currently at around $18.29 billion. The company operates more than 10,000 stores in 40 states, offering a wide range of discounted goods including packaged foods, personal care products, apparel, gardening supplies, hardware, and home office supplies. With a beta of 0.12, the stock is considerably less volatile than its benchmark, and is up around 12.7% in the last year, lagging the S&P.

Uneven economic recovery
While the headlines are full of reports touting the economic recovery in the U.S., as reflected in stock market all-time highs and strength in the housing market, not everyone has been able to benefit. For many Americans, things aren't that much better than they were a few years ago, and consumers are still cautious on spending in part due to the end of a payroll tax cut and weak disposable-income growth. According to some, this is boosting dollar store sales.

As a result, Dollar General has posted some very impressive earnings growth over the last few years, with annual EPS going from $0.47 in 2009 to $2.91 last year . For the first quarter of 2013, the company delivered record sales and net income, with net sales up 8.5% and same-store sales increasing by 2.6%.

With consumables performing especially well, in any case better than discretionary items, one could wonder what the following statement from CEO Rick Dreiling says about the state of the economy: "We believe that our customers' dependence on our everyday low pricing and convenient locations has never been greater [emphasis added]."

However, the company did moderate its outlook for fiscal 2013, now expecting a lower gross profit rate than previously anticipated. Still, things don't look too bad, with full-year total sales expected to increase by 10% to 11% and same-store sales to rise by 4% to 5%. Dollar General plans to open around 635 new locations throughout the year, and remodel or relocate some 550 stores .

Industry strength
Major competitor Dollar Tree (NASDAQ: DLTR  ) has also been coming out with some pretty good numbers recently, the most recent report showing a net sales increase of 8.8% and a same-store sales increase of 3.7%. According to management, the company is well positioned for the back-to-school and fall selling season, expecting low- to mid-single-digit same-store sales growth for the third quarter. Looking a little further out, however, the company's three-to-five-year expected EPS growth rate of 34.2% is considerably lower than Dollar General's hefty 56%.

Another competitor, Family Dollar (UNKNOWN: FDO.DL  ) , recently caught a downgrade from Deutsche Bank based on valuation, despite a third-quarter earnings beat. In the same report, Deutsche said Dollar General looked more attractive than Family Dollar going forward, citing easier comps and higher free cash flow. For the fourth quarter, the company is expecting continued pressure on discretionary products, in accordance with Dollar General's outlook . The company's expectation of fourth-quarter same-store sales of around 2% isn't too encouraging, nor is the expected three-to-five-year growth rate of 19.3%, at least compared to its competitors.

Valuations and metrics
In terms of P/E, there isn't much to separate the three companies discussed here. Dollar General trades at 19.21 times trailing earnings, versus Dollar Tree's 19.23 and Family Dollar's 19.95. Dollar General's forward P/E of 14.94 looks quite attractive, as does its 19.64% return on equity. Gross margin of around 32% is on par with the industry. Finally, the trailing-12-month operating cash flow of $1.09 billion is well ahead of the competition.

The bottom line
Various indicators have shown recently that the economic recovery so lauded in the media has not benefited everyone equally. In fact, it appears that it is another case of the rich getting richer. Dollar Store earnings support this notion. The discount retail industry is still posting fairly solid growth on the back of continued weak consumer spending. In the industry, Dollar General seems to be delivering the best growth, coupled with a reasonable valuation.

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