After reporting a dismal third quarter, Dollar General (NYSE:DG) announced a restructuring plan to sell inventory more quickly and efficiently, slow store growth, and close 400 underperforming stores at an estimated cost of $138 million.
Cleaning out the closet
Dollar plans to abolish its "packaway" model (which means what it sounds like -- the company packed away the inventory and hoped somebody would buy it) in favor of more aggressively discounting and getting rid of underperforming inventory. The company took a $79 million charge to get rid of old inventory, resulting in a $5 million loss for the quarter.
Because the charge is more a result of a buildup of bad inventory over a long period of time, rather than a recurring expense that will happen frequently (or so management hopes), it makes sense to exclude those charges when trying to figure out "normalized" results. Excluding non-recurring items, gross margin fell roughly 100 basis points, SG&A costs were up about 40 basis points, and operating income fell 27%. Shrink rate -- or inventory theft rate -- was up moderately, to 3.38% from 3.2% a year ago. For the quarter, sales per square foot were up slightly.
The next 50 Cent or the next Two-Buck Chuck?
Because of its ugly results, Dollar General might be a bargain. In the past year, Dollar's stock is down 20%, but its competitors, 99 Cents Only (NYSE:NDN), Dollar Tree (NASDAQ:DLTR), and Family Dollar Stores (NYSE:FDO), are up 20%-30%. Excluding the charge, Dollar's shares are trading at about 10 times the past year's operating income, and 8.5 times 2005 operating income.
The underperforming stores due for closure are probably operating at losses, so the shutdown should increase profitability. During the conference call, one analyst suggested this would result in a $0.10 benefit to earnings per share, which seems reasonable (by my calculations, this implies a roughly $75,000 loss per closed store). Management refused to quantify the benefit from store closure, but confirmed that it would be a positive impact.
If management can boost profitability through better merchandising and cut its losses from underperforming stores, then the current valuation may be too cheap. As noted in a very well-written Fool article, private equity firms might also provide current shareholders with a margin of safety. If the company doesn't make good on its initiatives, then a private equity firm might scoop up the company. Anytime a situation is heads I win, tails I don't lose, I'm interested.
For more on these deep discounters, check out:
- Brother, Can You Spare a (Five and) Dime?
- Family Dollar's Improving Performance
- Dollar Tree's Chilling Margins
Dollar Tree is an Inside Value recommendation. Family Dollar is a Stock Advisor selection.
Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. The Motley Fool has a disclosure policy. Emil appreciates comments, concerns, and complaints.
