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Dollar General's (NYSE: DG  ) performance so far this year has been surprising with shares up around 34%. The discount retailer has cut its guidance and reported mixed results more often than not this year as it has focused on selling more consumables and low-margin items such as tobacco. But investors have nevertheless remained optimistic about Dollar General as lower-income consumers continue to visit its stores. 

Impressive gains
More importantly, it looks like Dollar General's strategy of selling more consumable items in order to drive average ticket purchases higher is working. In the recently reported quarter, same-store sales increased 5.1% and revenue jumped 11.3% from the year-ago period to $4.39 billion.

However, the concentration of the product mix toward consumables, such as tobacco, has been hurting the gross margin, which declined 65 basis points from the year-ago quarter. Growth in non-GAAP net income was also slower than revenue. Dollar General reported adjusted net income of $251 million, up 8.7% from last year. 

On the positive side, it is evident that footfall is increasing. Revenue growth in the double digits is impressive as none of its peers managed to achieve this in their respective quarters. Management is of the opinion that Dollar General is gaining market share in consumables, and this should continue driving average ticket sales higher. 

Strategies worth noting
Dollar General has completed rolling out tobacco across all its stores, and management believes that this has been a key driver in improving sales. Two-thirds of customers bundle their tobacco purchase with one or more items. 

In addition, Dollar General has been rearranging and adding merchandise in its stores as well, and this seems to be proving fruitful. By better utilizing floor and shelf space, the company is looking to drive productivity gains in its older stores. In addition, it has also been rapidly expanding its store count and opened 375 new stores through the second quarter.  

Dollar General intends to open 650 new stores this fiscal year as it looks to extend its lead as the largest dollar store. Also, the company has just 69 stores in California, and it is focused on strengthening its position in that market further by optimizing its market entry strategy and using all its store formats to drive results. 

Installation of coolers for perishable items is also moving forward at a rapid pace, apart from updating the design of its stores to make them more customer-friendly. Management is of the opinion that the updated design has led to better same-store sale performance, and customer feedback has been positive. 

Dollar General's estimate-topping performance in the previous quarter and positive management commentary pushed the stock near its 52-week highs. However, the company remains cautious about its performance going forward and didn't boost its outlook.

Stiff competition
Dollar General competes with the likes of Wal-Mart (NYSE: WMT  ) and other dollar stores and competition in this space is stiff. In May this year, Bloomberg reported that prices at Wal-Mart are lower than Dollar General in most categories. Wal-Mart beat Dollar General on pricing in household goods 100% of the time while other items such as grocery, auto supplies, etc. were cheaper 85% of the time at Wal-Mart.

In addition, Wal-Mart has been looking to improve its presence in residential areas, thereby invading the turf of the dollar stores.

An alternative
At a trailing P/E of almost 20, Dollar General's valuation is in line with peers such as Dollar Tree (NASDAQ: DLTR  ) , which trades at a slightly cheaper 19 times earnings. But with an estimated annual earnings growth rate of almost 17% for the next five years for Dollar Tree, it might make for a slightly better bet than Dollar General. 

The factor working in Dollar Tree's favor is that it isn't selling tobacco to attract customers and as a result, its gross margin has remained steady. Dollar Tree is focusing on increasing store count and making stores more productive. It has around 4,800 stores at present and sees the potential for a total of 7,000 stores in the U.S.

In addition, Dollar Tree has 160 stores in Canada and believes that it can grow to 1,000 stores in the long run. As such, investors looking for a slightly cheaper and a tad more lucrative option might look at Dollar Tree as an alternative to Dollar General.  

The takeaway
Dollar General seems to be implementing the right strategies to improve sales, and they are bearing fruit as the previous quarter's results show. However, it is not the cheapest option among peers, and its margin might be under pressure going forward as sales of tobacco and consumables grow, while lower prices at competitors are another concern.

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9/23/2016 4:02 PM
DG $72.09 Up +0.20 +0.28%
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WMT $72.35 Up +0.08 +0.11%
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