DG is at 52-week highs, but there are headwinds on the horizon.
Bottlenecks in the supply chain, labor pressures, and consumer choice are all issues that the corporation faces.
A strategic approach to the correction.
The markets continue to debate whether inflation is temporary or permanent, but the very clear fact is that inflation is raging right now, as evidenced by yesterday’s CPI data, and while investors may dismiss its impact, the reality is that it will wreak havoc on dollar retailers, including sector leaders like Dollar General.
DG is an exceptional firm that has grown sales at a pace of 10.6% over the last five years while earnings have compounded at a rate of 17.9%. The company has over 17,000 outlets in 47 states and is particularly active in rural areas, where its smaller footprint gives it an advantage against Walmart. It’s also a well-run business, with free cash flow of 8.44 percent, a 77-basis-point dividend, and a P/E of 21. The company has stated that it will expand its healthcare product offerings across several of its stores, including health aids, medical, nutritional, dental, cough and cold, and feminine hygiene products.
The company is a well-oiled machine that remains a very appealing long-term investment. However, during the next six months, the company is anticipated to confront a slew of external challenges that might stifle growth and squeeze margins.
Although some of the worst supply-side constraints may be lessening, the truth remains that procuring products and, in particular, transportation of goods will continue to be significantly more expensive in the future, particularly as crude prices remain above $70/bbl. Because most of the company’s items have a “natural” price cap of one dollar, DG will undoubtedly face increased margin pressure on commodities sold. Despite the fact that DG and many other dollar merchants have expanded past the dollar mark on various things, people still regard that price as the anchoring point and may abandon businesses if they sense a decrease in value.
The tight labor markets for the company’s low-wage employees are maybe even more concerning than the supply chain concerns. According to some anecdotal accounts, the company is forced to operate limited hours due to personnel shortages, which impacts not only the store’s opening hours, but also the correct stocking and cleanliness of each box – a vital issue for long-term revenue growth.
During the zenith of the COVID panic, Dollar General was a major beneficiary of the pandemic flows, as their low-cost product provided a perfect option for cash-strapped and befuddled consumers. However, when the economy improves and consumer sentiment improves, buyers may choose more upmarket options, placing extra pressure on revenue growth.
The sharp drop in q/q growth indicates the possibility of a change in pace.
DG stock has remained well-bid, trading at 52-week highs despite the challenges ahead. However, the stock has often encountered resistance at the $220 level during the last year. Given the macro and micro challenges that the stock is facing, DG could be a smart short trade for the next six months. The Jan 21 220/200 put spread is currently trading at $7, implying that the market believes there is only a 35% chance the stock will go below $200 by year’s end. That may be overly optimistic, especially if the current supply chain restrictions and wage pressures linger until the end of the year. While DG is still a great long-term investment, it may be due for a correction, and the Jan 21 220/200 put spread is a low-risk way to play that move./n
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