A mere three years ago, discount retailer Dollar General (DG -0.41%) was one of the market's hottest stocks. The company had seemingly found a formula for smashing success, offering a wide selection of basic goods at a great price to small, underserved markets.
Between its 2009 public offering and its pandemic-prompted peak, Dollar General stock logged a gain of more than 1,100%. Its store count has also grown, from a little more than 8,800 locations then to over 19,000 now, pushing its annual revenue up from less than $12 billion to nearly $40 billion.
In retrospect, though, we can now see the company's growth wasn't built to last. Many of its stores are regularly understaffed, and untidy to the point of being unsafe.
Meanwhile, the company is struggling to effectively manage its inventory. Dollar General's planned markdowns for the latter half of the current fiscal year will cost it on the order of $95 million after a continued buildup of unneeded and unsellable merchandise through the middle of this year. And this year's same-store sales growth has been tepid at best.
The end result? Dollar General stock is still down by half from its late-2022 high despite the recent rebound effort. All of this begs one question: Is it even possible for this retailer to rekindle its past growth rate, or has its rural-focused business model passed its expiration date?
Dollar General paid for its big missteps
There's nothing wrong with dissecting a company's numerical results. After all, they're the ultimate measure of how well a company is doing. Being a great investor, however, also requires making well-reasoned judgment calls on a company's strategy and plausible growth prospects.
That's where Dollar General arguably runs into a stumbling block. See, a decade ago, the business model made sense. Although there are over 4,600 Walmart (WMT -0.08%) stores in the United States alone, they're largely found in more populated areas rather than small towns. Dollar General simply began filling this gap with a convenient, accessible, Walmart-like option. Today, roughly three-fourths of Dollar General stores are located in towns with populations of less than 20,000 people.
And the tactic worked -- at least for a while. As time marches on, however, a handful of flaws are being increasingly exposed. One of these is the difficulty and expense of managing a relatively small store. The average Dollar General locale only covers about 9,000 square feet. That's a lot, but not compared to the average Walmart store, which boasts on the order of 180,000 square feet of selling space.
This is a problem simply because smaller-footprint stores limit the number of employees that can be cost-effective hires, while at the same time limiting the amount of merchandise a Dollar General can offer. These stores must largely limit their selections to the basics, forcing the retailer's buyers to pick and plan very wisely. And they've not done a particularly great job on this front. The stores themselves haven't helped either; you can't sell an item that's in a box in an overcrowded stock room.
The retailer's disinterest in e-commerce has also been limiting. Although it does now offer some online shopping, Dollar General was late to this party, and still hasn't fully arrived. Not all of its items can be purchased online, and all online orders require the customer to pick them up at a store, or use a third-party delivery service like DoorDash. Even its usual rural customers can't ignore Dollar General's lack of evolution in online shopping.
Then there's the more big-picture reason why Dollar General is struggling: Management still seems relatively out of touch with what's actually happening in its stores.
Ch-ch-ch-ch-changes
But the situation isn't insurmountable -- in fact, the past couple years' worth of struggle have arguably been a much-needed wakeup call for the company.
Take its inventory management headache as an example. During August's earnings call, then-CEO Jeff Owen said Dollar General plans on spending up to $25 million on inventory-demand forecasting tools. This news follows May's announcement that the company would be expanding its network of distribution centers. Former Wayfair executive Peggie Fort has also been hired as Dollar General's inventory oversight chief.
It remains to be seen how quickly these measures will start to matter. Nevertheless, the retailer is now doing things it should have been doing long ago. We could begin seeing measurable progress on this front in 2024.
The company's getting serious about in-store staffing as well. Dollar General is going to spend up to an additional $150 million this fiscal year alone on labor, most of which will be spent on in-store hires. That's only around 5,000 more full-time workers' worth of spending -- less than its total number of stores. It's a start, though. If the investment pays off in sales growth and reduced shrinkage, don't be surprised if Dollar General expands this investment in the future.
DG Revenue (TTM) data by YCharts
Perhaps the most overwhelming change underway with Dollar General right now is a rather sweeping overhaul of its management team. Fort is hardly the only newcomer -- CFO Kelly Dilts, Vice President of Growth and Emerging Markets Steve Deckard, and Vice President of Global Supply Chain Rod West have all been hired this year.
In the meantime, CEO Todd Vasos is back as CEO after briefly stepping down from a seven-year stint at the helm last year. While one could argue he planted the seeds of several of the company's current problems while he was leading the growth charge, it's difficult to deny he knows Dollar General about as well as anyone can.
Looking five years down the road
But the question remains: Will this be enough to send Dollar General stock higher in either the near or distant future? It would be naïve to believe the next 10 years will be as fruitful as the past 10 have been. If nothing else, the discounter is running out of places to build new stores. Nevertheless, the new and improving Dollar General is being underestimated by investors and analysts alike.
There is a market for smaller-footprint stores that serve as grocers in areas where a full-sized grocery or general merchandise store isn't nearby. But these consumers still expect such a venue to carry all the basics and some discretionary goods in a tidy environment. The company seemed to lose sight of this simple retailing premise a few years ago, perhaps distracted by the introduction of fresh produce and frozen foods. It now seems to be getting back to its roots, with new tech, new leadership, and a real investment in the people on the front lines.
It's still not clear where Dollar General stock will be five years from now. What is clear is that the stage is set for a firmly higher price. The stock's rout since late last year only grows the scope of its prospective recovery.
