Category: Sectors

Business Strategy and Outlook

Despite intensifying competition that we believe is diminishing its competitive edge, Dollar General’s advantageously located store network, low-priced items, and leverageable supply and distribution capabilities should allow it to deliver economic returns. With a footprint focused on thinly populated areas that cannot support numerous retailers and make shipments to homes costly for a small basket (over 80% of items are priced at or below $5), we expect Dollar General to use its burgeoning scale and proximity to customers to economically deliver the convenience and affordability that its generally modest-income (roughly $40,000 annually, as a household) customers demand. 

Still, switching costs are negligible, forcing Dollar General to face intense competition from convenience stores, mass merchandisers, hard discounters, grocery stores, pharmacy chains, and online retailers (Amazon). The crowded landscape puts a premium on execution, a challenge management has met thus far but requires agility as customers’ demands change.

Financial Strength

With stores that have remained open through the pandemic, ample liquidity, and negligible near-term maturities, the firm is well positioned to endure a volatile fiscal 2021-22 as the economy normalizes. The firm has a history of limited leverage, with net debt roughly equal to adjusted EBITDA over the past five years, on average. It is expected that such prudence to continue. Despite aggressive growth (from under 9,000 stores at the start of fiscal 2010 to more than 17,000 at the end of fiscal 2020), free cash flow generation has been strong. 

Furthermore, in the event of financial strain, Dollar General should be able to hold additional funds as needed by simply curbing its unit growth targets, reducing capital expenditure needs, which we forecast to average 2%-3% of sales over the next decade, or more than $1 billion annually.Dollar General introduced a dividend in fiscal 2015, with a payout ratio averaging nearly 20% over fiscal 2015-20. 

Bulls Say’s 

• Low price points and average ticket sizes protect the dollar store segment from digital incursion as shipping costs are difficult to absorb, all while allowing firms to sell smaller package sizes at higher margins. 
• Dollar General capitalizes on a broad network of stores, which include rural locations that are often the only convenient sizable retailer. 
• With its stores considered essential, a consumablesheavy lineup, and potential to capture trade-down sales, Dollar General should largely sidestep the COVID-19 pandemic’s adverse economic consequences.

Company Profile 

A leading American discount retailer, Dollar General operates over 17,000 stores in 46 states, selling branded and private-label products across a wide variety of categories. In fiscal 2020, more than 76% of net sales came from consumables (including paper and cleaning products, packaged and perishable food, tobacco, and health and beauty items), 12% from seasonal merchandise (such as toys, greeting cards, decorations, and gardening supplies), 7% from home products (for example, kitchen supplies, small appliances, and cookware), and 5% from basic apparel. Stores average roughly 7,400 square feet, and about 75% of Dollar General locations are in towns of 20,000 or fewer people. The firm emphasizes value, with more than 80% of its items sold at everyday low prices of $5 or less.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Business Strategy and Outlook

With a besotted member base, low-frills warehouses, and growth opportunities at home and abroad, it is expected that Costco’s durable competitive advantages lead to consistent, strong performance despite retail’s upheaval. The competitive environment is intense and becoming more challenging as Amazon scales and physical rivals deliver an omnichannel experience, but it is believed that the values that Costco offers (driven by cost leverage, procurement strength, and top-class store efficiency) should allow it to keep traffic high. With ample opportunity to expand globally, Costco Is expected to post consistently strong returns even as it grows. 

Through a financial crisis, the maturation of digital general merchandise retail, the expansion of Amazon’s Prime offering, a credit card provider switch, a robust pre-pandemic economy, two meaningful fee increases, and the COVID-19 outbreak, Costco’s membership renewal rates in the United States and Canada have remained at roughly 90%. The traffic-driving values that Costco offers in its stores are fueled by cost leverage and procurement strength that, in turn, feeds additional store visits. 

As per Morningstar analyst perspective, it is believed that the firm’s food and fuel offerings drive traffic and suspect that Costco is poised to thrive even as digital sellers expand. Although it is expected to keep pace with rivals by further developing its omni channel offering (a mid- to high-single-digit share of fiscal 2021 sales, excluding same-day grocery and various other services, came from e-commerce), it is  believed that Costco’s value proposition should support continued member growth and in-store sales expansion.

Financial Strength

With strong cash flow generation and a dedicated subscriber base, Costco is in good financial health. Costco had $11 billion in balance sheet cash as of the end of fiscal 2021 against just $7.5 billion in debt. The geographic mix of new store openings will shift as Costco grows to more than 1,000 warehouses; it is expected that openings and digital investments will leave capital expenditures at roughly 2% of sales, in line with the firm’s five-year average. Despite the spending, analysts expect the firm will be able to balance growth with returning capital to shareholders without meaningfully altering its leverage metrics. Morningstar analyst expects that firm’s conservative balance sheet approach to endure despite continued share repurchases. With free cash flow to the firm expected to average around 2%-3% of sales (consistent with recent results), it can be observed that Costco has significant financial flexibility. It is suspected such returns will include special dividends, which Costco paid in fiscal 2013, 2015, 2017, and 2021. 

Bull Says

• Costco’s membership format exhibits strong customer loyalty, with renewal rates holding steady around 90% in a variety of economic environments and despite Amazon’s growth (particularly Prime) and the broader digitization of retail. 
• Costco’s focused assortment reduces complexity while concentrating its buying power, which we believe grants it exceptional procurement leverage. 
• Costco should be a safe harbor in retail seas roiled by the COVID-19 pandemic, with its competitive advantages holding returns steady.

Company Profile

The leading warehouse club, Costco has 815 stores worldwide (at the end of fiscal 2021), with most sales derived in the United States (72%) and Canada (14%). It sells memberships that allow customers to shop in its warehouses, which feature low prices on a limited product assortment. Costco mainly caters to individual shoppers, but roughly 20% of paid members carry business memberships. Food and sundries accounted for 40% of fiscal 2021 sales, with non-food merchandise 29%, warehouse ancillary and other businesses (such as fuel and pharmacy) nearly 17%, and fresh food 14%. Costco’s warehouses average around 146,000 square feet; over 75% of its locations offer fuel. About 7% of Costco’s global sales come from e-commerce (excluding same-day grocery and various other services).

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.