Dollar General | NYSE: DG | Price: $74.

95 | Date: 11/15/16

Target Price: $110.00 | Intrinsic Value: $103.48

Company Overview
Dollar General is the largest U.S. discount variety chain by number of BUY
stores.As with other industry players, Dollar General offers a variety of Industry: Retailing
general merchandise at heavily discounted prices. Sector: Retail
Market Cap:
21.19B
Beta: 0.79
P/E: 17.59
P/B: 3.88
ROE: 22.70
ROA: 10.69
Yield: $1.00
Div: 1.34%
LT Growth: 12.9%
52 Week Range:
$59.75-$96.88

Investment Thesis Risks

Due to an overreaction to lower than expected • Declining government

earnings and same-store sales growth from the latest spending towards SNAP and
quarter, Dollar General experienced a 22% price tighter eligibility restrictions
decline. We believe the consensus overemphasized
the impact from decreasing government welfare • U.S. election causing
spending. We are impressed by Dollars General’s uncertain future on foreign
ability to generate consistent high levels of cash flows trade.
and its strong historical top and bottom-line growth.
We believe Dollar General’s advantageous cash • Pricing war could continue to

position enables the firm to sustain an aggressive pressure margins growth

buyback plan, accompanied with rising dividend
• Vulnerability to deflation on
payments. We have an intrinsic value of $103.48 for
key products
the stock, implying an undervaluation of 39.09%.
Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 1
DOLLAR GENERAL - NYSE: DG NOVEMBER 15, 2016

Negative News
Upon releasing 2nd quarter results, Dollar General’s stock price dropped 22% as a result
EPS missing consensus’ estimates by $0.01. This drop can be credited to operational
inefficiencies and unfavorable macroeconomic trends.

Same-store sales growth for the quarter came at an underwhelming rate of 0.7%. This
slower-than-expected result was perceived very negatively given that it was down from a
2% increase in the first quarter and below management’s goals of 3% same-store sales
growth. CEO Todd Vasos attributed the weakening same-store sales performance to a
greater than anticipated headwind from price deflation across key perishable items and a
reduction in the participation rate and benefit level from the Supplemental Nutrition
Assistance Program.

Milk and eggs retail prices, the two largest products within perishables, were down
nearly 8% and 50%, respectively. Furthermore, declining government investing towards
the Supplemental Nutrition Assistance Program will have a negative impact on the
company’s average ticket amount as the purchasing power of Dollar General’s core
customers decline.

Following the purchase of 42 Wal-Mart express locations, the company will need to
relocate 40 existing Dollar General stores. This is will create leasing conflicts that will have
a negative impact of $0.02 to $0.03 towards diluted EPS.

The operations of the company are proving to be undergoing a period of inefficiency

with increasing shrink and markdowns. Dollar General has reduced retail prices by 10%
on nearly 450 of their best selling SKUs across 2200 stores, representing nearly 17% of
its store base. We suspect this strategy reflects their reaction to a heightened competitive
environment.

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 2
Thesis Breakdown
Strong Fundamentals
Same Store Sales Performance
According to the Congressional Budget Office, Office of Management, and the Bureau of
Economic Analysis, it’s expected that the spending from SNAP is likely to continue
declining until 2020. The consensus predicts an improving economy will diminish the
need for significant SNAP investment, as well as a return to pre-recession normalized
investment levels. However, we believe the slow pace of economic recovery in low-
income households will prevent massive cuts in welfare spending. The consensus
estimates that SNAP caseloads will decline to pre-recession levels by 2020. However,
variables strongly positively correlated to SNAP funding, such as poverty rate,
participation rate, food insecurity levels, remain significantly above pre-recession levels.
The number of households classified as food insecure has grown by 30% since 2007.

The dollar and variety store industry has always been one with high competition. Dollar
General has been able to remain a top performer despite the high level of competition
and pricing wars. We see same-store sales improvement resulting from increased store
traffic and the introduction of higher margin products.

Dollar General has a strong history of top and

bottom-line growth. Sales have increased at an
average annual growth rate of 9.36% over the past
five years, while net income has increased at an
average of 13.45%. While gross margin has been
declining mildly, Dollar General has been able to
reduce SG&A expenses through the zero-base
budgeting program, an initiative that aims at cutting
any costs that don’t add value to the customer
experience. We expect management’s cost cutting
efforts to continue increasing the firm’s operating
margins during the next 3 to 5 years.

On August 25th, due to lower than expected same-store sales growth, the company
released Q2 earnings that missed EPS consensus estimates by $0.01. As a result, Dollar
General lost 22% of its value despite its fundamentals remaining intact.

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 3
Top and Bottom-Line Performance
Cash
Strong Cash Position
Dollar General’s business model allows the firm to generate substantial cash flows. The
company has been able to maintain an average cash balance of $178 million during the
past five quarters. We believe the firm’s ability to consistently generate substantial cash
flows is an important aspect of its undervaluation. Most notably, the company has
generated operating cash flows of over $1 billion since 2012, always higher than the
previous period.

Buybacks and Dividends

The cash position allows the firm to execute its expansion initiatives without becoming
highly leveraged. Management has announced an expansion plan for 2017 that targets
the opening of 1000 new Dollar General’s stores throughout the U.S., with 800 of them
already on the pipeline. The discrepancy between operating cash flows and the amount
of cash added each quarter is a result of higher PP&E expenses caused by expansion
initiatives, and by an aggressive share repurchase and dividend policy. On August 14th,
the company’s Board of Directors authorized the repurchase of $1 billion of common
shares in addition to the $400 million that was previously available. Dollar General has
consistently repurchased over $200 million in common shares during the past five
quarters, and the newly announced buyback plan of $1 billion leads us to believe this
positive trend will continue during the next five years. We expect dividends to increase at
a lower rate of 8% to 10% during 2017 due to difficulties originating from pricing
pressure and lower SNAP participation rates. From 2018 to 2022, we believe the firm will
be able to sustain dividend growth between 15% to 20% as economic conditions
improve.

Economic Outlook
Millennials are quickly becoming the largest population segment in the U.S., and we
believe Dollar General will be able to capitalize on key characteristics of this age group.
For instance, considering Dollar General offers low-priced routine items, the company’s
business model appeals to Millennials’ mindset of spending less on necessities and more
on luxurious goods and services. In addition, the company is actively seeking for
methods to attract this group. For instance, the company is investing in key growth
initiatives such as offering web and mobile services, as well as reaching out to the
younger crowd through social media.

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 4
Economic Drivers
Per Capita Disposable Income
We expect higher disposable income per capita to be a major driver of same-store sales
during the next five years. Among Dollar General’s core clients (>$40,000), higher levels
of disposable income will result in larger store traffic and sales transactions. We also
believe the company will be able to retain its wealthier customers as income rises due to
the inclusion of higher-priced national brand products among the firm’s merchandise.

Valuation

FCFE
The FCFE model resulted in an intrinsic value of $103.48, implying an undervaluation of
39.09%. Our EPS expectations are slightly higher than the consensus’, reflecting our
positive outlook for the company. We predict rising depreciation and CapEx expenses as
a result of Dollar General’s aggressive expansion initiatives. We utilized a discount rate of
8.42% based on an adjusted CAPM.

Free Cash Flow to Equity Model

2015 2016 2017 2018 2019 Terminal Value
EPS 3.96 4.51 4.92 5.56 6.23 131.01
Depreciation/share 1.2 1.235 1.271 1.307 1.345
CapEx/share -1.71 -1.81 -1.92 -2.04 -2.16
NWC/share -0.98 -1.27 -1.66 -2.15 -2.80
FCFE 2.47 2.66 2.61 2.68 2.62
PV of FCFE $2.46 $2.22 $2.10 $96.70
Intrinsic Value $103.48
Stock Price 74.4
% to fair value 39.09%
Discount Rate 8.42%

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 5
 Dollar General's FCFE Sensitivity
Discount Rate
6.87% 7.47% 8.07% 8.67% 8.73% 8.79% 8.85%
3.05% $137.77 $117.70 $102.46 $90.51 $89.45 $88.42 $87.41
3.30% $147.12 $124.51 $107.62 $94.53 $93.38 $92.26 $91.16
Perpetuity Growth Rate 3.55% $157.88 $132.18 $113.34 $98.94 $97.69 $96.46 $95.26
3.80% $170.40 $140.90 $119.73 $103.81 $102.43 $101.09 $99.77
4.05% $185.13 $150.89 $126.91 $109.02 $107.68 $106.20 $104.76
4.30% $202.73 $162.46 $135.05 $115.21 $113.52 $111.88 $110.26
4.55% $224.13 $176.01 $144.35 $121.95 $120.06 $118.23 $116.45

Multiple

We conducted a P/E expansion model to estimate a reasonable 3-year price target. We

expect Dollar General’s P/E to expand to a multiple of 17.66 by 2019. The model resulted
in a 3-year target price of $110.

Price to Earnings Expansion Model

2016 2017 2018 2019 2020
EPS $4.51 $4.92 $5.56 $6.23 $6.85
P/E $15.80 $17.25 $18.17 $17.66 $16.98
Price $71.32 $84.87 $101.01 $110.00 $116.34

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 6
Business Overview
Business Model
“Save Money. Save Time. Everyday!

Dollar General distinguishes itself by delivering competitive low prices in both small and
large markets. Its stores are strategically designed to get clients in and out quickly during
convenient hours and locations.

Convenient Locations Time-Saving Shopping

‣ The company establishes its stores
in close proximity to its core
customers, which drives customer
loyalty, trip frequency, and creates
an attractive alternative to larger
discount retailers.
‣ ExperienceThe firm’s small box stores are
easy to get in and out of quickly. The
convenient hours and broad merchandise
offering allows customers to obtain their
basic necessities while minimize their
need to shop elsewhere.

Everyday Low Prices on Quality Merchandise

‣ Dollar General’s ability to offer everyday low prices on quality merchandise is
supported by its low-cost operating structure and its strategy to maintain a limited
number of items per merchandise category. It offers quality nationally brands at
everyday low prices in addition to similar-quality private brands at value prices.
Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 7
Growth Opportunities
The company has opportunities to expand, relocate and remodel the existing store base
to better serve its customers. Characteristics of the business model that have allowed the
company to continue implementing the successful expansion strategies include low
initial capital requirements and low store operating costs.

Operations
The typical Dollar General store is operated by a store manager, one or more assistant
store managers, and three or more sales associates. The stores feature a focused
merchandise offering within a broad range of categories. They are 7,400 square feet and
nearly 70% of them are located in towns of 20,000 or fewer inhabitants. Many of its
stores are subject to build-to-suit arrangements with landlords, which typically carry a
primary lease term of up to 15 years with multiple renewal options. They also have stores
subject to shorter-term leases, many of which have leases renewal options.

Distribution
Its stores are currently supported by thirteen distribution centers. Most of its merchandise flows
through its distribution centers and is delivered to stores by third-party trucking firms, utilizing
Dollar General`s trailers. Sporadically, vendors and third-party distributors ship certain food
items and other merchandise directly to stores.

Consumers
Dollar General’s customers are attracted to the firm’s low prices and convenient shopping
experience. The company’s core customers are low and fixed income households who are often
underserved by other retailers. During the last fiscal year, 66% of sales derived from shoppers
which average annual income is less than $40,000. The remaining 44% derived from shoppers
that earn between $40,000 and $57,000 per year.

Suppliers
Dollar General purchases its merchandise from a wide number of suppliers. During the
most recent fiscal year, the two largest accounted for a total of 14% of total inventory
purchased. The company secures its flow of inventory by establishing long-term
relationships with them. While the loss of certain suppliers could impact the firm’s
performance, we believe Dollar General is well prepared to obtain alternative sources or
merchandise without seeing any substantial disruptions to the business.

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 8
Products
Dollar General offers high-quality national brand products along with similar-quality
private brand products that are sold at discounted prices. The company’s product
assortment is partially responsible for the firm’s ability to offer products at competitive
prices. Limiting each product category to only a certain number of items allows Dollar
General to have a pricing advantage in dealing with suppliers. The products are
separated into four categories: consumables, seasonal, home products, and apparel.

Competitive Landscape
Competitors
Dollar General has 6 major competitors across the U.S. and holds 30.90% of the market share.

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 9
Competitive Moat
Dollar General doesn’t have a wide competitive moat, however, the company has certain
operational advantages over its competitors. First, the company’s ability to generate cash
flows is relatively higher than those of competitors, which allows the company to
capitalize on expansion opportunities more efficiently. Second, the company has been
able to establish itself as the industry leader among dollar stores, which facilitates
maintaining relationships with suppliers, as well as acquiring inventory at lower costs
than its competitors.

Risks Breakdown
Government Policies and Regulations
Demand for Dollar General’s products is dependent on consumer’s discretionary income.
The company exercises no control over the future of governmental programs, many of
which have a direct impact on the firm’s core clientele. Therefore, terminations and
modifications of welfare programs, such as the return of the three-month-limit rule to the
Supplemental Nutrition Assistance Program (SNAP), could have a material impact on the
firm’s same-store sales performance. Other governmental actions that could adversely
impact Dollar General’s ability to grow sales and sustain margins include: changes to the
minimum wage, higher taxes, higher-than-expected interest rate hikes, credit availability,
and labor regulations.

Political Uncertainty
The unexpected result of the presidential election creates market uncertainty and
augments the government regulation risks stated above. In particular, changes in trade
policy with China could adversely impact the firm’s ability to offer its products at
competitive prices and to sustain healthy margins. Despite certain states recently
approving an increase in minimum wages, the inception of the new government
increases the likelihood of a prolonged period of low minimum wages nationwide.

Price Deflation
Price deflation has weighed on Dollar General’s margins since the start of 2016 and could
continue to present difficulties for the firm. Price deflation is most notable in the
consumables market, where the price of milk and eggs dropped by 8% and 10% during
the second quarter, respectively.

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 10
Intense Competition
Dollar General faces fierce competition from other discount stores and a variety of
retailers. Pricing pressure from competitors could result in loss of profitability and
customer base. In particular, major retailers are implementing aggressive price cuts in an
attempt to increase store volumes. There is evidence of a price war occurring in the
consumables market. However, the company has been historically successful overcoming
competition and maintaining its position as an industry leader.

Company Management
Todd Vasos - CEO

Mr. Vasos has served as Chief Executive Officer and a member of Dollar General`s board
since June 3, 2015. He joined Dollar General in December 2008 as Executive Vice
President, Division President and Chief Merchandising Officer and he was promoted to
Chief Operating Officer in November 2013. Prior to joining Dollar General, Mr. Vasos
served in executive positions with Longs Drug Stores Corporation for 7 years, including
Executive Vice President and Chief Operating Officer (Feb. 2008 through Nov. 2008) and
Senior Vice President and Chief Merchandising Officer (2001 – 2008). He also previously
served in leadership positions at Phar-Mor Food and Drug Inc. and Eckerd Corporation.

John W. Garratt - Executive VP and CFO

Mr. Garratt has served as Executive Vice President and Chief Financial Officer since
December 2, 2015.Prior to joining Dollar General, Mr. Garratt held leadership positions in
corporate strategy and financial planning at Yum! Brands, Inc. between May 2004 and
Oct 2014.He began his career in May 1990 at Alcoa, where he served for approximately
9 years.

Jim Thorpe - Executive VP and CMO

Mr. Thorpe returned to Dollar General in August 2015 as Executive Vice President and
Chief Merchandising Officer, with over six years of previous employment experience with
the Company. Following his retirement from Dollar General, Mr. Thorpe provided on a
limited ad-hoc basis certain retail industry consulting services as President of JW Thorpe
& Associates, Inc. Prior to Dollar General, he served in various positions of increasing
importance and responsibility with Sears Holdings Corporation from March 1991 to May
2006.

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 11
Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 12
Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 13
Analysts
Luiz Arruda has a 4.0 GPA and served as an undergraduate research
assistant at USF for nearly two years. He also received the Excellence in
Undergraduate Research award. Arruda interned with AXA Advisors, where
he analyzed clients' portfolios and researched mutual funds. He is highly
involved at USF, serving in a leadership role for Global Business Brigades
and participating in the Corporate Mentor Program, where he is paired with
a mentor from the business community. The Brazilian native speaks three
languages – Portuguese, English, and Italian.

Jose Ortiz spent two high school years in his homeland of Mexico, saying
the experience helped him better understand Latin American culture and
how business operates there. He joined USF as a member of the invitation-
only Bulls Business Community which serves high-achieving students. Ortiz
enjoyed the program so much that he volunteered to mentor three
incoming business students the following year. His finance acumen, bi-
lingual skills, and understanding of Latin American business led to an
internship in Miami for Beta Capital Management. There he handled equity
research and conducted anti-money laundering investigations.

Samuel Rodas is a Peruvian native whose family moved to the United States
when he was 8 years old. Rodas is the first in his family to attend college. He
has held an internship at Wells Fargo Advisors, where he assisted two
financial advisors. Rodas is a member of two honor societies: Phi Theta
Kappa and the National Society of Collegiate Scholars. He is also a member
of the Student Finance Association. Rodas aspires to work in corporate
finance and to earn a master's degree in finance.

A finance and MIS double major, Laura Del Castillo aspires to work in equity
research. She is well on her way as she has held three internships in the
finance industry. She worked as a financial operations consultant at
JPMorgan, served as a credit risk management intern at Raymond James,
and interned as a controller at Goldman Sachs. Del Castillo is an active
leader and has held numerous positions such as president of Toastmasters,
co-leader for a career workshop, and coordinator for a missionary trip. She
speaks three languages and is an artist and pianist.

Analysts: Luiz Arruda, Laura Del Castillo, Sam Rodas, Jose Ortiz 14