Why Wells Fargo Downgraded Dollar General Stock

Wells Fargo downgraded Dollar General (DG) stock to “market perform” from “outperform” on July 25. Wells Fargo remains positive about the company’s prospects but sees certain risks at its current valuation level. It’s kept its price target for Dollar General stock unchanged at $140.

Dollar General stock fell 1.0% on July 25. The stock has a “buy” rating from 20 out of the 29 analysts (or 69%) following the retailer. Eight analysts have “hold” recommendations, and one calls it a “sell.”

Dollar General stock has risen 27.4% year-to-date as of July 25, outperforming the 18% rise in rival Dollar Tree (DLTR). The stock is also ahead of the S&P 500, which is up 19.8% so far this year. On July 25, the 12-month average price target for Dollar General stock was $140.24, implying an upside potential of about 2.0%.

Dollar General stock has risen 16.2% since it announced its first-quarter results in May. The company exceeded analysts’ forecast for first-quarter sales and earnings. Dollar General’s first-quarter sales increased 8.3% to $6.62 billion with same-store sales growth of 3.8%. Higher average retail prices and improved customer traffic benefited its top line growth.

Dollar General’s adjusted EPS rose 8.8% to $1.48 in the first quarter. Higher sales and a reduced share count owing to share repurchases drove its bottom line growth. Analysts expected sales of $6.57 billion and EPS of $1.39.

Dollar General outperformed Dollar Tree in the first quarter. Dollar Tree’s sales grew 4.6%, while its adjusted EPS fell 4.2%. Read Dollar General or Dollar Tree: Who Fared Better in Q1? for a detailed comparison of the two.

Dollar General continues to optimize its store network to improve customer traffic and boost sales. The discount retailer opened 240 new stores in the first quarter as part of its plan to open about 975 new stores in 2019. Also, the company remodeled 330 stores and relocated 27 stores in the quarter.

Overall, the company’s goal is to remodel 1,000 stores in the current year and relocate about 100 stores. About 500 of the remodeled stores will have more coolers so that the company can offer an expanded assortment of perishable items.

Additionally, Dollar General is expanding its presence in metropolitan areas as well as in rural areas with low populations through its smaller-format stores. These stores are less than 6,000 square feet in size compared to the company’s traditional 7,300-square-foot format.

Earlier this year, Dollar General announced two new initiatives, DG Fresh and Fast Track. The DG Fresh initiative will help the company move to a self-distribution model for fresh and frozen products. The company commenced shipping from its first DG Fresh facility in Pennsylvania in January this year. It believes that its DG Fresh initiative will enhance its top line and bring down product costs. Dollar General plans to open three more self-distribution facilities this year.

The company’s Fast Track initiative is structured to improve its in-stock position and enhance labor productivity. Under the first phase of its Fast Track initiative, the company is optimizing sorting processes in its distribution facilities to improve store-level stocking. The second phase of this initiative will test a self-checkout option in certain stores.

On July 25, Dollar General stock was trading at a 12-month forward PE multiple of 20.3x. In comparison, Dollar Tree’s forward valuation multiple was 19.2x. Dollar General expects net sales growth of about 7.0% and same-store sales growth of 2.5% in 2019. It expects its 2019 EPS to be in the range of $6.30–$6.50.

Analysts expect Dollar General’s sales to rise 7.4% to $27.5 billion in the current year. They expect its adjusted EPS to rise 8.4% to $6.47.

Dollar General’s efforts to boost the sales of its consumable products, initiatives to enhance nonconsumable offerings such as home merchandise, and store optimization efforts are expected to drive its performance this year.