Dollar General (DG -0.41%) will likely make a critical transition in the coming years. As one of the leading ultra-discount retailers, it has long been in a growth mode, steadily expanding a footprint that now spans more than 19,000 stores.
However, when a competitor like Walmart can only support around 5,300 U.S. stores, one has to assume Dollar General is nearing a saturation point. And like Walmart stock before it, Dollar General will probably transition from a growth to a value play in the foreseeable future.
Consequently, Dollar General investors will have to see whether it can succeed as a dividend-paying value stock.
The state of Dollar General stock
Admittedly, Dollar General already looks like a value stock in many respects. It sells for a price-to-earnings (P/E) ratio of about 16, very close to a 10-year low for the stock. Unfortunately, its P/E ratio was at 26 one year ago.
This is likely because it has dramatically underperformed its archrival Dollar Tree (NASDAQ: DLTR) over the past year. As Dollar Tree revamps Family Dollar stores and cuts prices, it has grown same-store sales faster than Dollar General by reducing its gross profit. This may force Dollar General to cut its prices, thus pressuring its margins.
DG PE Ratio data by YCharts
Additionally, the company still spends heavily on expansion. Though it cut back on the number of new stores it planned to open, it spent $363 million in property and equipment in the first quarter of fiscal 2023 (ended May 5) and almost $1.6 billion in this category in fiscal 2022 (ended Feb. 3).
Dollar General and the dividend
In Q1, that spending contributed to the company's negative free cash flow. This occurred at a time when it spent $129 million on dividends. This is an ongoing issue since the $424 million in free cash flow in fiscal 2022 failed to fully cover $494 million in dividend costs.
Given that situation, one has to question whether its dividend is stable. The company just raised its payout to $2.36 per share, a payout that has increased annually since its reintroduction in 2015.
However, even after the increase, the dividend yield is only 1.4%, below the S&P 500 average of 1.5%. With only about $313 million in cash and equivalents, it may have to issue stock or increase debt to sustain this payout.
Investing in Dollar General
Given the state of the company and the upcoming transition, investors should refrain from adding shares at this time for dividend income or any other reason.
For one, moves by its principal competitor Dollar Tree have negatively affected sales. This likely means that Dollar General will either have to accept lower sales levels or tighter margins. Both of these options bode poorly for the stock.
Moreover, the company continues to raise a dividend that has become increasingly unaffordable. Admittedly, its property and equipment expenses should fall as its rate of expansion slows. Nonetheless, until the company proves it can boost its free cash flows significantly above its dividend costs, Dollar General stock will likely not serve growth or income investors well.
