Not long ago, I gave three reasons Dollar General's (DG -0.59%) stock could fall in the coming year. The company faces an onslaught of challenges, including intensifying competition, lower household income among America's poor, and a CEO change right as the company needs experienced leadership. Each of those threats has the potential to derail Dollar General's stock price, but there are also opportunities that could offset or even eliminate the threats.
Source: Wikimedia Commons.
Investors should know both sides of the story before making an investment decision. So let's see what could drive Dollar General's stock price higher in the months and years ahead.
1. New stores and remodels to boost profitability
Unlike most retailers, Dollar General has significant room to expand its store count. The company had 11,215 stores in 40 states at the end of its fiscal 2014, which ended Feb. 28. It plans to add 700 stores in fiscal 2015, thereby expanding its store count by 6%. If Dollar General successfully acquires Family Dollar (FDO.DL), management plans to slow down its growth plans to integrate the two companies before ramping back up to 4% to 6% annual store growth.
In addition to expanding its store count, Dollar General is also relocating or remodeling underperforming stores. Through Q2 2014, the company had relocated or remodeled 585 stores -- 159 more than the number of new stores it opened. This serves as a hidden source of growth; the 4% to 6% new store growth fails to account for relocations that are essentially the closure of one underperforming store and the opening of another more promising store. As a result, Dollar General's revenue growth has significant tailwinds.
2. Same-store-sales growth
Adding new locations is one way to grow revenue, but a healthy company continues to grow revenue even at mature locations. Dollar General has an impressive track record of same-store-sales growth; fiscal 2013 marked its 24th straight year of positive same-store-sales growth. This illustrates Dollar General's resilience throughout the business cycle.
Nevertheless, Dollar General's same-store-sales growth is decelerating. Same-store sales grew 6%, 4.7%, and 3.3% in 2011, 2012, and 2013, respectively. However, a strengthening economy and potential action by state or federal legislatures to raise the minimum wage could boost sales growth in the coming years. Of course, both of those events are speculative and may not occur, but Dollar General has shown that it can grow same-store sales by a significant margin given the right environment.
3. Expand private-label business
Dollar General could significantly expand its profit margin by expanding the share of private-label sales as a percentage of overall revenue. National brands tend to draw in customers, but Dollar General earns a higher gross profit on store-brand products. Moreover, private-label products tend to have lower price points than national brands; if low-income consumers continue to suffer, Dollar General's customers may buy more private-label goods out of necessity.
But Dollar General isn't going to just sit back and wait for consumers to make the switch themselves. Instead, the company is repackaging its private brands to refresh its image and proactively attract more consumers to the higher-margin products. The company is already seeing promising results from this initiative, which launched in August.
Raising its gross margin would give a considerable boost to Dollar General's earnings. The company's gross profit as a percentage of sales was 30.77% over the past four quarters. That's 1.3 percentage points below its high of 32.04% in fiscal 2011. If the gross margin percentage increases by just one percentage point, Dollar General's operating profit would increase by 10%. That's why the company's private-label initiatives could potentially raise its stock price.
Takeaway
Dollar General has two promising ways to grow revenue and one promising way to grow profit as a percentage of revenue. If all three act in concert, Dollar General's stock price could rise significantly in the years ahead.
