Commentary

Undervalued Company of the Week – DG

The company of the week this week is Dollar General Corporation (DG), a discount retailer that offers an assortment of general merchandise.  As we did last week, we will be looking reviewing the company using Warren Buffett’s approach for the Business & Management Review.  We will also use Benjamin Graham’s overall philosophies to guide our Financial & Value Review.

Business & Management Review

1.  Is the business simple and understandable?

     Dollar General Corporation is in a simple business of providing goods to consumers at a low price.  The company operates in a niche market of “profitable small stores delivering convenience and value.”  The general store has been a simple and easy to understand business for centuries, and that is no different today.  Dollar General focuses on obtaining as much quality as possible while maintaining the lowest possible price.

2.  Does the business have a consistent operating history?

     The company was founded in 1955 as a pioneer in the dollar store concept.  The original stores offered all merchandise for a price of $1 or less.  While not all of their products sell for $1 or less, the overall operating strategy has not changed over time.  Dividends have been paid consistently for at least the last 20 years.  Today, the company operates over 8,200 stores in 35 states. 

3.  Does the business have favorable long-term prospects?

     Dollar General appears to have favorable long-term prospects.  The company has grown well throughout its history, and has room to continue its growth.  Since it only operates in 35 states, there is ample room left in the United States to at least make a push for a larger market share in 15 states.  We were surprised to find that there is not a single store in California.  It is our belief that opening stores in California would be favorable long-term.  In addition, the company recently began to open Dollar General Market stores, a larger version of their traditional stores that includes an expanded food section.  With success in the Market stores, the company has potential to grow this division.

4.  Is management rational?

    We are encouraged with management’s performance the last few years.  The company has grown substantially, and the management is using excess cash to increase dividends and buy back stock – actions that are very pleasing to the value investor.  We are also encouraged with the way management responded to a decrease in same-store sales in the fourth quarter of 2005.  Management did not panic and seek vast changes to their operating strategy, but kept the strategy focused while fixing minor tactical issues in their operations.

5.  Is management candid with its shareholders?

     We were happy to find management providing Free Cash Flow figures in annual reports.  By being open with shareholders and providing this information straight out, it is clear that management understands that it is in everyone’s best interest to be candid in all manners of business.  We believe all companies should adopt policies to provide GAAP statements and reformulated statements for financial analysis.  Instead of all the manipulation accountants do to cover up various financial issues, it all should be disclosed in the open (not the footnotes) in an easy to understand format.

6.  Does management resist the institutional imperative?

    Management appears focused on placing the most talented individuals as possible in positions of importance.  This resists the institutional imperative all by itself.  How often have managers put the shareholders’ interests aside in order to hire friends?  We believe that in order to be successful in business, managers must hire subordinates who are more talented than themselves.  Dollar General seems to follow this trend, and over time the individuals that work for the company will steadily improve in talent, thus leading to a more successful company in the long-term.
 

Financial and Value Review

Upon our review, we find Dollar General Corporation to be suitable for the enterprising investor but not the defensive investor following Benjamin Graham’s value investing strategy.  The company’s current ratio, failure to increase EPS on a significant level over the last 10 years, and its price to book ratio eliminate it from the defensive investor’s portfolio.  With a PE ratio (see Our Methods) of 14.35 and an ROIC of 11.14%, we believe this is an excellent investment opportunity.

We believe the company has potential to reach $20/share in the next few years. 

Neither of us held a position in Dollar General Corporation at the time of publication.  Also, please read our disclaimer and Our Methods.

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