The odds are good you occasionally drive by one, even if you have never set foot inside one. Dollar General (NYSE:DG) operates more than 16,700 stores in 46 states and notably targets the smaller markets that bigger rival Walmart (NYSE:WMT) generally shuns. It's also spent the last few years tiptoeing deeper into the consumer staples market, chipping away at Walmart's hold on consumers with a faster and simpler shopping trip thanks to smaller store footprints.
The formula it's following has undoubtedly worked. Dollar General's store count has nearly doubled in just the past 10 years. And while most retailers have been stymied by COVID-19, this discounter's top line grew 24% year over year during the second quarter. Same-store sales improved by nearly 19%.
The second quarter is a microcosm (albeit an accelerated one) of the company's historical success. Dollar General hasn't posted lower revenue in any quarter in over a decade, and operating income growth has been almost as impressively consistent. The stock price has reflected the retailer's growth as well, up more than 800% over the course of the past 10 years.
Now the company is experimenting with higher-income consumers and developing a storefront called popshelf, breaking it out of its relatively narrow focus on lower-income neighborhoods and setting the stage for another decade of incredible growth. In short, the company seems to be doing everything right.
And there's the rub. As perfect as things seem on the surface, Dollar General may be at an "as good as it gets" moment. Ditto for the stock.
Running out of low-hanging fruit
Don't misread the message. Dollar General doesn't face an existential crisis. With 75% of its 16,720 stores found in towns with populations of less than 20,000 -- relatively underserved markets -- Dollar General is here to stay.
Its best high-growth days may be behind it, though. A couple of things lead to this possibility, not the least of which is simple math that ultimately points to saturation.
According to Census Bureau data, as of 2018, there were just under 19,500 incorporated cities or towns within the United States. Only 780 of them boast populations in excess of 50,000 people, which plays into Dollar General's success with smaller communities. But nearly 14,800 of these towns have populations of less than 5,000. That figure falls perhaps at the lower end of areas that can reliably support a Dollar General store. Add in the more than 15,000 stores owned and operated by Dollar Tree (NASDAQ:DLTR) under the same name as well as Family Dollar, and Dollar General and the dollar store industry as a whole may be running out of places to build stores where they enjoy a competitive advantage.
The introduction of popshelf is a seemingly savvy way to combat this potential saturation. In some regards, though, the experiment subtly underscores the notion that saturation is turning into a significant challenge. There's also little assurance that popshelf will be able to recreate the sort of success that the Dollar General brand has enjoyed for years now.
Popshelf will still sell bargain-priced goods like its sister Dollar General, for the record. However, where Dollar General is mostly geared toward consumer staples, popshelf will focus on discretionary products and more affluent shoppers. The company explains that these stores will sell more seasonal goods, home decor, party supplies, health and beauty products, and more to consumers likely to live in households with annual earnings of between $50,000 and $125,000.
The strategy makes sense. But it will not only increasingly pit Dollar General head-to-head against Walmart in more population-packed areas where such incomes are more common, it will also face off with value-minded "fun" stores like Five Below (NASDAQ:FIVE) and Party City (NYSE:PRTY).
Again, Dollar General isn't doomed. There are still pockets of the country that can support new Dollar General stores. Existing stores are still cash cows. Popshelf will eventually find its place.
However, currently priced at 24 times its trailing 12-month earnings and more than 23 times next year's projected bottom line, Dollar General shares are not only priced at the upper end of their historical valuation range, they're priced for the sort of growth that may be tougher to come by than recent buyers expect. Shares of rival Big Lots (NYSE:BIG) aren't valued as richly as Dollar General is, currently trading at only 8.8 times next year's estimated per-share earnings even with comparable growth prospects. Meanwhile, even bigger-but-slower Walmart is cultivating a customer ecosystem that Dollar General can't. Subscription-based Walmart+ offers unlimited free deliveries, and the retailing giant has expanded its e-commerce offerings, added healthcare clinics and health insurance to its services, and is trying out technology service teams that look a lot like Best Buy's Geek Squad.
As long as Dollar General is priced like it is in this current, highly competitive environment, the prospective reward doesn't quite jibe with the risk -- at least for potential new investors.