Fears of slowing global economic growth have spooked investors. With the S&P 500 Index down about 2% year-to-date, it might be time for investors to prepare their portfolios for a recession. If the economy enters a downturn, investors should take a closer look at the types of stocks that stand to outperform.
Deep-discount retail is an area that should continue to outperform if the economy enters a recession. There could even be an argument made that dollar stores like Dollar General (DG) will actually benefit more from a recession.
Dollar General is a high-quality dividend growth stock. The current yield is fairly low at 1.1%, but Dollar General has the ability to raise its dividend by 10% or more each year. Resilience during economic downturns and high dividend increases make Dollar General an ideal dividend growth stock for the next recession.
Dollar General was founded in 1939. The company was privately-held until it conducted its initial public offering in November 2009. Today, it is the leading U.S. “dollar store”, meaning it sells many products for $1 or less. It sells a wide variety of merchandise, including consumables, seasonal, home products, and apparel. The stock has a market capitalization of approximately $28 billion. Dollar General operated 15,227 stores in 44 states as of November 2, 2018.
In early December (12/4/18), Dollar General announced third-quarter 2018 financial results. Revenue of $6.42 billion increased 9% from the same quarter a year ago, driven by same-store sales growth of 2.8%. Diluted earnings-per-share increased 36% for the quarter, due to sales growth, a favorable comparison from the year-ago quarter due to hurricane expenses last year, share repurchases, and a major benefit from tax reform. It was a solid performance for Dollar General overall, as the company beat analyst expectations on both revenue and earnings last quarter.
Dollar General reduced full-year earnings guidance for 2018 after reporting third-quarter earnings, which is why the stock is trading roughly 10% off its 52-week high. due to higher-than-anticipated expenses this year. The company is investing heavily in growth, which is expected to weigh on profitability in the near-term. However, these investments will also fuel the company’s future growth. Dollar General still expects at least 9% sales growth for 2018, along with at least 30% earnings growth, driven largely by sales growth and a $300 million benefit from tax reform.
Over full economic cycles, Dollar General expects to deliver high single-digit sales growth, and at least 10% annual earnings growth.
Dollar General plans to open approximately 900 new stores, remodel 1,000 stores and relocate 100 stores during the 2018 fiscal year. It also plans to open another 975 new stores in 2019. These investments are necessary to keep pace with the highly competitive retail industry, and the emergence of e-commerce competitors like Amazon. Dollar General’s strong brand and focus on low-priced goods are competitive advantages that secure its target customer demographic.
Share repurchases are another driver of earnings growth. Dollar General expects to repurchase $850 million of its own shares this year, which will further boost earnings growth. All else being equal, Dollar General’s buybacks could add 3% of earnings growth this year.
Dollar General expects to reach annual sales of $30 billion by 2020, which would be a 50% increase from 2015. Overall, we expect 10% annual earnings growth for Dollar General over the next five years, through a combination of new store openings, comparable sales growth, benefits from tax reform, and share buybacks.
Dollar General has a highly secure dividend. Its payout ratio is likely to remain below 20% for 2018. The company is highly profitable, with a low payout ratio that leaves plenty of room for 10% annual dividend increases. Dollar General also enjoys significant competitive advantages that will keep its dividend secure. It is the leading operator in the dollar store industry, with a lean cost structure. And its earnings should hold up very well during a recession, perhaps even growing through an economic downturn.
Consumers typically scale down their spending levels during a recession. When times are tough, people usually tighten their belts. Instead of spending at higher-priced retail outlets, consumers are likely to increase their visits to their local dollar store. This means Dollar General is a rare type of business that might actually benefit from a recession.
As you can see in the above image, Dollar General grew net sales, same-store sales (which measures growth at stores open at least one year), and sales per square foot each year during the recession. The company generated particularly strong growth rates - including same-store sales growth of 9% or more - during 2008 and 2009, the worst years of the Great Recession.
Therefore, investors can feel confident about the company’s dividend increases continuing during a recession, which few companies can do. Dollar General increased its dividend by 11.5% in 2018, and another increase is likely to be announced for the April 2019 declaration. It is reasonable to expect the company will increase its quarterly dividend to at least $0.32 per share, which would represent a 10% increase. The current yield is fairly low at 1.1%, but with double-digit increases each year, the yield on cost can rise quickly.
In addition to the 1.1% dividend yield and 10%+ dividend growth, Dollar General stock is modestly valued. Based on 2018 earnings guidance, shares trade for a price-to-earnings ratio of 17.7. This is exactly equal to the average valuation multiple the stock has held over the past 10 years. As a result, we view Dollar General as at least fairly valued, and potentially undervalued due to the company’s high expected earnings growth.
With global economic growth showing signs of weakening, it’s not a bad time for investors to get defensive. It has been nearly a decade since the U.S. last experienced a recession, which is longer than the average duration between economic downturns. There could be an argument made that the U.S. is “overdue” for a recession. If this occurs, investors should consider adding some defensive stocks to their portfolios.
Dollar General is arguably the perfect stock to own in a recession. The company has the ability to grow during all economic cycles. Its financial performance actually accelerated during the Great Recession. Dollar General’s sales and earnings growth should continue to grow at a high rate if and when the U.S. enters another downturn. This should keep its 10%+ annual dividend increases intact for the foreseeable future.
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