Should I Do It? Pennies on the Dollar General

The anticipated economic slowdown from higher energy prices and rising interest rates has taken a bite out of discount retailers, most notably in the dollar-store arena. Dollar General (DG) is a leader in this segment and is trading 33% off its 52-week high of $20.65 a share back on July 21, 2005.

But does the recent decline provide a buying opportunity, or should investors stay on the sidelines?

Dollar General pioneered the dollar-store concept in 1955 and now has more than 8,000 stores nationwide. Over the past few years, consumers grew accustomed to the idea of shopping in stores in which most products could be bought for under $1. High demand, primarily from consumers who make less than $30,000 annually, opened the door to competition for other discount retailers.

Today, below-$1 stores are everywhere. Dollar General is not only seeing competitive threats from public under-dollar companies such as Family Dollar ( FDO), Dollar Tree ( DLTR) and 99 Cents Only Stores ( NDN), but many private mom-and-pop discount stores also are saturating the market.

Increased competition and rising fuel costs are cutting into Dollar General's bottom line. On March 21, the company reported fourth-quarter earnings of 46 cents a share, lower than the 49 cents analysts were expecting. The company cited weak traffic, which is viewed as a red flag in retailing.

On June 2, Dollar General reported first-quarter EPS of 15 cents, a penny below Street estimates, and narrowed full-year 2006 earnings-per-share guidance from $1.14 to $1.21 to $1.09 to $1.16. Before the report, shares were trading slightly above $16 a share and but have since declined sharply to $13.50.

But a long-term turnaround could be in the making. David Perdue, the chairman and CEO of Dollar General, recently announced a restructuring plan that includes adding more brand-name products, such as Heinz ketchup and French's mustard, improving the in-store presentation and increasing promotional spending during the holidays. These efforts do not offer a quick fix, but long term, they could be effective.

At the current price of $13.50, shares of Dollar General are trading at 11 times 2007 earnings, or a 30% discount to their five-year average. The stock has a long-term growth rate of 14%. Dollar General's more than 8,000 stores -- an increase of 3,000 stores since February 2001 -- are in 32 states, and the company expects to open 800 new stores during 2006.

Dollar General has $90 million in cash and pays a 1.5% dividend, which is covered by more than six times 2007 expected earnings. Next year's earnings could see double-digit growth compared with fiscal year 2005 depressed levels.

However, despite these positives, I would not say Dollar General is a good buy now. A prudent move is to wait at least three to six months to re-evaluate the effectiveness of the company's restructuring plan. Also, earnings estimates for some firms still need to be adjusted, and positive news from Dollar General in the next quarter could provide a nice base for entry.

To view Frank Curzio's video take of this column, click here .

In keeping with TSC's editorial policy, Frank Curzio doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Frank X. Curzio is a research associate at TheStreet.com, where he works closely with Jim Cramer. Previously, he was the editor of The FXC Newsletter and senior research analyst for Greentree Financial.

He appreciates your feedback; click here to send him an email.

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