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).
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.
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).
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
Walmart U.S. continues to impress, putting up a strong U.S. comp of 2.8% while leveraging operating expenses. The momentum the company has in the U.S. business allows it to further invest in its growth, whether through price and/or convenience. Our research suggests that this does appear to be the case, as the company seems to be implementing a fresh round of price investment (see our Midweek note Here We Go Again…), particularly in food. Taking a step back on why we remain Underperform rated, the overall company’s earnings and ROIC continues to be subdued by losses from international investments (Flipkart), and while it is still too early to tell, our research does suggest that Amazon’s move to one-day delivery and reacceleration in North America could lead to a potential slowing of sales for WMT, or necessitate further investments in distribution infrastructure. Coupling these risks with an equity that is trading well above its historic valuation leaves us Underperform rated, though we are raising our target price to $105. (from $95).
Topics this week…
Consumables Corner – 1) Walmart appears to be implementing prices cuts, 2) CPI and PPI data continues to spell bad news for grocery retailers, and 3) SPTN earnings preview
Walmart’s World – WMT earnings preview
Quotes of the Week – Grocery Outlet (GO, Not Covered) Vice Chairman, MacGregor Read, on store expansion
Topics this week…
Consumables Corner – Southern California pricing data shows heavy deflation in the fresh category
A to Z – Amazon is having more of an impact on the consumables industry than most realize, in our opinion
Quotes of the Week – Ahold Delhaize (AD-NL, Outperform, €25 PT) CEO, Frans Muller, on strike recovery actions
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