Elevated Investments to Protect Dollar General’s Brand but Dampen 2023 Returns

Dollar General’s DG Feb. 23 preliminary release quenched any speculation about its fiscal 2022 fourth-quarter earnings, leading investors to focus on 2023 guidance during the Mar. 16 call. As we digest more specific commentary around higher capital, operational, and debt-servicing expenditures in 2023 than our prior forecast, we expect to trim our $212 fair value estimate by a low-single-digit percentage, rendering shares fairly valued.

More concretely, management’s goal of $1.8-$1.9 billion in capital expenditures in 2023—partially due to higher construction costs associated with the buildout of the distribution network—tops our $1.4 billion estimate, while larger investments in strategic initiatives (including an incremental $100 million investment in associate hours to boost on-shelf availability) crimp operating leverage. We believe that these investments are prudent, given the intensifying competition in discount retail, and stand to protect the firm’s intangible asset that underpins our narrow-moat rating.

Turning to revenue, Dollar General’s value-oriented product suite resonated with cash-strapped consumers in the fourth quarter despite Winter Storm Elliot’s drag on sales, increasing its share of core consumers’ wallets and trips in all segments. To this effect, the firm recorded its highest private label penetration and absolute dollar growth in the quarter, as lower-income consumers looked to trade down, and as higher-income individuals were lured to its stores.

We are pleased with Dollar General’s progress on its long-term strategy, leaving our long-term thesis and 7% average annual sales growth intact. With its nonconsumable initiatives gaining steam, Dollar General aims to gain traffic and increase trips with a quickly refreshed merchandise, borrowing a successful tactic from no-moat Five Below. Additionally, the expansion of produce, coolers, and health offerings should bolster its appeal by concentrating a variety of essential products conveniently.