This Discount Retailer Continues to Impress

There are dramatic differences of opinion in which way the economy is truly headed. This leads to many investors being skeptical about potential investments. The good news for the company discussed in this article is that it doesn't matter what happens throughout the broader economy.

Leading by example
Dollar General (DG 0.82%) is the largest discount retailer in the United States when measured by store count -- currently 10,866. More importantly, Dollar General opened 375 new stores in the first half of the year while only closing 15 locations. This is telling.

In the current economic environment, with a cautious consumer negatively impacting sales, many retailers are looking toward divestments as a way to cut costs and grow the bottom line. It's extremely rare to see a retailer open this many more stores than it closes. 

The point here is that Dollar General is clearly confident in its future potential, and this makes sense. If the economy recovers, Dollar General will still attract low-income, middle-income, and fixed-income consumers. If the economy suffers, then Dollar General might attract even more consumers, especially middle-income consumers who are looking for better values than where they currently shop.

Dollar General recently noted that the 2% payroll tax increase, as well as government cuts over the next several years, could impact results, but this is likely more about Dollar General hedging its own potential.

If you look at this from a logical perspective, people need to shop for goods, especially consumables. That being the case, consumers who are required to budget more than in the past are likely to opt for a dollar store to shop for those consumables. And Dollar General is looking to grow in the consumables area since it's seeing higher demand for consumables than in its other product areas. While consumables have lower margins, this increased demand should help the top line.

A glance behind and a look ahead
In addition to Dollar General opening 375 new stores in the first half of the year, it also remodeled and relocated 377 stores. By updating and moving under-performing stores, margins are likely to improve.

To increase traffic, transaction amount, and sales per square foot, Dollar General has undertaken several initiatives:

• Optimize space in mature stores
• Improve merchandise in-stock levels
• Offer more coolers for refrigerated and frozen foods
• Add tobacco products
• Expand roll-out of beer and wine

As far as traffic and transaction amount, these initiatives would lead to further improvement. In the second quarter, comps jumped 5.1% year-over-year, primarily due to improved increased traffic and increased average transaction amount.

The shiniest dollar
Many investors and analysts like to debate which dollar store offers the best investment opportunity. The truth is that Dollar General, Dollar Tree Stores (DLTR -1.23%), and Family Dollar Stores (FDO.DL) are all likely to be quality long-term investments.

All three companies benefited from the Great Recession, when consumers became more value-conscious. These consumers are likely to remain loyal to the dollar stores, even with the upcoming threat of Wal-Mart's small-store roll-out.

Put simply, people don't like change unless it's necessary. While Wal-Mart's small-box stores have the potential to steal market share away from neighboring dollar stores, it's too early to consider these stores to be a considerable threat.

Getting back to dollar-store comparisons, let's take a look at top-line performance for the three aforementioned companies over the past five years:

Dollar Tree revenue trailing-12 months data by YCharts

And bottom-line performance over the past five years:

Dollar Tree EPS diluted trailing-12 months data by YCharts

Though these three companies tend to perform similarly, Dollar General looks impressive. It's also trading at 15 times forward earnings, versus 17 and 18 times earnings for Dollar Tree and Family Dollar, respectively. However, some other key metrics favor Dollar Tree:

Dollar Tree turns the most revenue and investor dollars into profit, and its debt management is superior to Dollar General and Family Dollar. However, this isn't to say that any of these companies have debt concerns. They all generate enough cash to cover debt obligations. And Family Dollar's halfway decent yield is a bonus if you're looking for dividend payments. All of that said, Dollar General is still solid across the board.

Checkout
If you're looking for an investment in a company that's capable of growing in all economic environments, consider Dollar General, or one of its peers. The only concerns for Dollar General are higher demand for lower-margin products (consumables) and Wal-Mart's roll-out of small-box stores, which are specifically designed to steal market share from the dollar stores.

Most Dollar General customers, however, are likely to remain loyal. For Dollar General, as well as its peers, upside potential outweighs downside risk.