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Morningstar | Ongoing Strong Execution at Dollar General Boosts Our Optimism, but Shares Appear Fairly Valued

Reflecting continued strong execution and second-quarter results, we are lifting our near-term targets for narrow-moat Dollar General, resulting in a revised $107 per share valuation (up from $98). Still, the revisions do not alter our long-term outlook, calling for mid-single-digit top-line growth and adjusted operating margins of just under 9% over the next decade, on average. While we have a favorable view of the retailer's prospects even as the competitive landscape shifts, we suggest investors await a more attractive entry point.

We believe Dollar General has capitalized on its efficiency, advantaged store locations (with roughly 70% of units in rural areas, which we believe can support only a limited number of retailers), and leverageable supply and distribution architecture to deliver low prices and convenience to consumers of modest means. With such shoppers short on time and funds, we believe the firm's value proposition is attractive, with more than 75% of Americans living within five miles of a Dollar General store and about 80% of items priced at $5 or less. The company has also wisely invested in remodeling mature stores and new technology that should add to its standing with customers, including a mobile app that delivers coupons and allows shoppers in certain stores to scan and pay for items using their phone, without a cashier.

Contrary to much of retail, we believe consumers' desire for convenience (particularly for the fill-in trips that the chain targets) and cost leverage support Dollar General's ongoing footprint expansion. However, we expect the pace to moderate, with average annual square footage growth falling under 5% over the next decade, relative to Dollar General's 7% average over the last three fiscal years. Still, expansion should combine with low-single-digit same-store sales growth to drive mid-single-digit revenue gains, enabling cost leverage that should leave profitability near recent levels despite intensifying competition.

Although Dollar General is better positioned than most retailers, in our view, the competitive landscape is nonetheless becoming less favorable, leading to our continuing negative moat trend rating. As digital retailers scale and develop the distribution network depth to economically deliver to less densely populated areas, we expect Dollar General's convenience advantage to erode. Additionally, hard discounters' growth plans threaten to add incremental low-cost competition, particularly as retailers such as Aldi have long relied on inexpensive, private-label heavy assortments. Still, we do expect Dollar General's cost advantage to endure, particularly as it continues to add to its footprint and leverage distribution and supply chain costs.