We had the opportunity to spend some time with both Dollar General (DG, Outperform, Target Price $165) and Tractor Supply (TSCO, Peer Perform, Fair Value $106) senior management teams (CEO, CFO and IR), as well as walk through the stores on Tuesday in Nashville.
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We continue to view DG as a best-in-class operator with a strong long-term growth and earnings outlook. Indeed, as the company expands ongoing initiatives such as remerchandising non-consumables categories, expanding its cooler and fresh offering, investing in its distribution infrastructure, and rethinking/improving its distribution and in-store processes, our research suggests that growth could actually accelerate over the next few years. This idea is bolstered by our analysis showing significant white-space for new stores, as well as the growing appeal of the DG format across income demographics. Given Dollar General’s strong return profile and potential for accelerating growth, we view the company as a “must own” equity and are reiterating our Outperform rating, rolling forward and raising our CYE20 Target Price to $165 (From CYE19 Target Price of $142).
Best Buy report strong 2Q EPS before the market opened on 8/29 and raised guidance, however the sales outlook was a bit muted and there remain concerns around the impact from tariffs specific to the company, but also in relation to consumer demand. This, we believe, led to a selloff in the equity. With that said, our research suggests the company remains a unique operator, as it is one of the only companies with a national footprint to showcase the plethora of new devices and technology slated to come to market over the next 12-36 months. Further, the company continues to invest in its service offerings through acquisitions, partnerships, and programs such as Total Tech Support. Taken together, we believe BBY is setting itself up for sustainable, long-term growth. With valuation attractive, in our opinion, Best Buy remains one of our top long-term ideas and we are reiterating our Outperform rating.
The Smucker’s team is waging a gallant fight to maintain growth both on the top and bottom-line. Indeed, the company has moved aggressively to gain exposure to faster growing categories like Pet, as well as launch new products/brands in its existing portfolio. The challenge, however, is the competitive climate remains elevated in most areas of its business, as much larger operators such as Nestle and General Mills invest behind competing brands in hopes of driving their growth algorithm. At the same time, retail giants like Walmart push to enhance private label offerings in Smucker’s core areas of peanut butter and jelly. Our research suggests that this environment likely will continue and, perhaps, even get worse. This, in our view, will pressure both top-line and bottom-line results and we are reiterating our Underperform rating.
Our Walmart CPG price tracker through last week shows a continuation of price cuts, especially in Food. Our Food basket is flat sequentially and down 1.1% y/y, while our HPC basket is down 0.3% sequentially and up 0.9% y/y. For U.S. based food companies, we continue to see risk around the pricing environment if Walmart reinstates a new round of price cuts.
While BJ’s 2Q19 came in ahead of our expectations, comparable sales of 1.6% continues to lag most of the company’s peers in the strongest consumer economy in a decade, which to us signals that the company still has significant work to do to improve the business. While management certainly has acknowledged that it will continue to work towards providing a better value proposition for its customers to drive memberships on multiple fronts, we do not see how this will be possible without a meaningful financial investment. BJ’s in currently on-pace for a fifth straight year of gross margin expansion, a rarity for a consumer staples retail company in a highly competitive environment, and our research indicates that it will need to at some point increase investments in order to drive sales growth. Relative to a year ago, the company seems to be making operational headway and is more derisked from both a financial leverage perspective and the equity exit from one of two financial sponsors.
. It appears that LOW is making progress in addressing the gross margin issues that arose in 1Q19, and that it continues to have several initiatives that should lead to stronger margins going forward, a more productive asset base, and drive incremental sales growth. The company is currently undergoing significant changes to its store inventory and supply chain, merchandising and pricing analytics with its integration of Boomerang Retail Analytics, as well as its website with its re-platforming of Lowes.com to Google Cloud (HD did this over 3 years ago). As such, we continue to forecast continued gross margin improvement as well as SG&A leverage into FY20, and believe that further store changes should help accelerate sales growth as well as enhance EBIT margin and ROIC. As such, we are reiterating our Outperform rating and CYE19 $125 Target Price.
Target’s ability to maintain its strong sales growth while delivering another quarter of profitability, with 32bps of gross margin expansion and 51bps of SG&A leverage, was certainly a surprise. It appears to us that TGT had (and likely still does have) spare capacity in its fixed and labor asset bases for incremental productivity. While on an “all-else-equal” basis, we continue to view a digital sale and carrying a lower margin than a pure in-store sale for an identical basket, Target’s performance appears to demonstrate that there is enough excess capacity in the store that the marginal revenue exceeds the marginal cost of the digital sale. Through 1H19, TGT has demonstrated not only that it could revitalize sales growth in its stores, but that it would be able to do so without deteriorating the cost and margin structure of its business. While there is potentially upside to both earnings and multiple expansion if results continue, we see the current equity price as adequately reflecting the growth potential and long-term risks, and we remain Peer Perform rated with a Fair Value near $105 (from low $80’s).
HD is a brick house capable of standing up to the multiple headwinds facings the home improvement market. Comparable sales of 3.0% were respectable especially given the difficult weather in May as well as mixed housing macro data, and earnings surprised despite the company’s ongoing investments into developing an industry leading omnichannel business. Looking through the end of the year, we continue to see upside for HD as the company expands its direct distribution and one-day delivery infrastructure, continues to roll-out in-store efficiency improvements, and navigates through the turmoil caused by trade disputes and broader macroeconomic uncertainty. We view the company as among the better positioned to mitigate the impact from tariffs as its vendors shift manufacturing and we continue to view the fundamentals for home improvement spend in the U.S. as being supportive of HD’s long-term growth.
Topics this weekend…Target's Tidings - TGT 2Q19 Consumables Corner - BJ 2Q19 Hardline Happenings - HD 2Q19 and LOW 2Q19 Quote of the Week – Walmart, Inc. (WMT, Underperform, $105 PT) President and CEO, Walmart eCommerce U.S., Marc Lore on the 2Q20 Media Call
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