In terms of share price, Dollar General (NYSE:DG) has handily dusted rival discount retailer Dollar Tree (NASDAQ:DLTR) so far this year. Dollar General's stock has appreciated nearly 31% year to date, while Dollar Tree's stock, though enduring similar volatility through the coronavirus pandemic, has managed a gain of just 0.7%.
Both retailers reported fiscal second-quarter 2020 results on Aug. 27. Through the first six months of the year, Dollar General enjoyed a 20.2% rise in comparable-store sales against the prior-year period, while its revenue increased 26%, to $17.1 billion. Dollar Tree's comps advanced 7.1% in the first six months of the year, and total revenue improved by nearly 9%, to $12.6 billion. Below, we'll explore why Dollar General appears to have a built-in edge over Dollar Tree, and why this advantage may remain for some time to come.
Leveling the comparison field
One of the ways we can compare two very similar retailers is to understand their respective approaches to total selling area. As of the second quarter of 2020, Dollar General boasted 123.6 million square feet of selling space, versus an almost identical 123.1 million square feet utilized by Dollar Tree. Dollar General ended the second quarter with a store base of 16,720 units; Dollar Tree was narrowly behind with 15,479 stores, divided fairly evenly between its namesake brand and the Family Dollar chain.
It should be noted that Dollar Tree has slightly curbed overall net store expansion over the last few quarters as it has worked to turn around the Family Dollar Brand. This effort is paying off, as Family Dollar's emphasis on food and household consumables has reaped rewards during the COVID-19 pandemic. The Family Dollar segment posted comps growth of 11.6% in the second quarter, versus 3.1% growth for Dollar Tree branded stores.
While adding stores helps drive revenue higher, how a company uses its selling space is ultimately much more important to financial performance. Below is a telling view of selected metrics for the first six months of fiscal 2020 for each company, expressed in terms of square feet:
|Metric (Per Square Foot)||Dollar General||Dollar Tree||Percentage Difference|
|Free cash flow||$20.10||$7.90||154%|
The table above illustrates that Dollar General is much more efficient than its competitor in squeezing sales, profits, and cash flow out of each available square foot of selling space.
Part of Dollar Tree's profit and cash flow inefficiencies relative to Dollar General can be explained by its 2015 purchase of Family Dollar. While Family Dollar's prospects are finally brightening, the chain has proved quite the project for management since its acquisition, dragging down overall company gross margin, which used to exceed that of Dollar General:
An enduring edge for Dollar General
Now, a few points of gross margin deterioration don't really explain the gap in economic-value creation between the two companies. An excerpt from the business model description in Dollar General's most recent annual report holds a vital clue: "Our merchandise includes national brands from leading manufacturers, as well as our own private brand selections with prices at substantial discounts to national brands. We offer our customers these national brand and private brand products at everyday low prices (typically $10 or less) in our convenient small-box locations."
Despite marketing itself as a "dollar" store, Dollar General embraces price flexibility of up to $10 per item. Dollar Tree branded stores, in contrast, continue to sell each item for $1. (The company has lately experimented with an in-store concept called Dollar Tree Plus, which offers merchandise at price points of $5 or less.)
Dollar General's higher price points versus its consumer staples competitor allow it to grab more sales per square foot, and this supremacy flows throughout the income statement, as well as the statement of cash flows. Dollar Tree's purchase of Family Dollar, which also offers flexible price points of $10 or less, was undertaken to diversify its business model and increase productivity per square foot. But Family Dollar contributes a little less than half of total Dollar Tree revenue, so the effect is somewhat muted.
A higher sales yield per square foot is meaningless unless Dollar General can procure inventory at a favorable cost, distribute products to stores efficiently, and maintain a loyal and growing customer base. The company has been able to optimize on these fronts over the last few years, while Dollar Tree's management has devoted an inordinate amount of time to the purchase, integration, and turnaround of the Family Dollar Brand. It appears that an inherent advantage in Dollar General's business model is only growing firmer as time goes on.