The cash drain is the real story at Dollar General (DG Quote - Cramer on DG - Stock Picks).
The company's shares fell 30% Monday after it issued a press release saying it
expects to restate three years' worth of earnings because of "accounting irregularities." Yet the retailer's statement offered no details about the abnormalities. The company declined to comment for this story, adding that it currently has no plans to hold a conference call to explain the restatements.
Absent an explanation from the company, investors are coming up with their own hunches -- and most center on inventory management. A close look at Dollar General's numbers shows that, compared with, say,
Family Dollar (FDO Quote - Cramer on FDO - Stock Picks), the company has long struggled to stem cash flow losses from operations, partly due to problems related to inventory.
Detail-Disoriented
After a preliminary investigation, the Goodlettesville, Tenn.-based company estimates that the restatements will reduce combined earnings for the fiscal years 1998, 1999 and 2000 by 7 cents, or some 4% of the $1.81 earned over that three-year period. (The company's so-called 2000 fiscal year ended Feb. 2, 2001. In its press release Dollar General calls this latest year fiscal 2000, though fiscal years are typically referred to by their ending date. In the interest of consistency, this story will refer to years as they were designated by Dollar General.)
The restatement appears small. But the lack of detail and the admission by Dollar General Monday that it's also "reviewing allegations of fraudulent behavior in connection with certain accounting irregularities" has clearly fazed the market. The company's stock dropped $7.38 Monday to close at $16.50. Before this plunge, it was up 27% this year as investors wagered on a 2001 recovery following a difficult 2000.
"This is something of a surprise," says Michael Glick, director of corporate credit at
CreditRiskMonitor.com, which tracks the ability of companies to pay their trade creditors. "This is very distressing news."
Investors need to remember that reviews of irregularities can turn up more phantom earnings and revenue than first expected. Last November
Lucent (LU Quote - Cramer on LU - Stock Picks) originally thought it had overstated fourth-quarter fiscal 2000 revenue by $125 million, but by December the company had upped that number to $679 million, more than five times as much.
Shrinkage
Dollar General on Jan. 22 said that it would report fourth-quarter earnings well short of expectations partly because of a "higher shrink expense." Translation: The company had underestimated how much of its inventory had been stolen or misplaced due to poor management. "This may have prompted them to dig deeper," surmises Glick.
A month later, Dollar General's finance chief, Brian Burr, was replaced by James Hagan. On April 5, Burr filed to sell 126,597 Dollar General shares, yielding estimated proceeds of $2.9 million.
Jeff Matthews, manager of the
Ram Partners hedge fund, notes that, over the past four years, changes in many of the items that make up working capital (current assets minus current liabilities) at Dollar General have proved to be a serious drain on cash, while Family Dollar's working capital changes have produced only a small deficit. Changes in working capital items related to operations totaled negative $55 million in 1997 (that is, the 12 months ended in January 1998), minus $30 million in 1998, minus $160 million in 1999 and an estimated negative $123 million for 2000. The total deficit at Dollar General for the four years was around $368 million, while at Family Dollar it was minus $7 million. Matthews' fund has no position in Dollar General.
Lesson from all this? While a company that long struggles with cash flows isn't predestined to fiddle with its books, it should never come as a surprise when it does.
Peter Eavis
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