Dollar General Corporation (DG) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us. We are here at the Goldman Sachs 27th Annual Global Retailing Conference. I'm Chandni Luthra, the U.S. discounters analyst. And it is my pleasure today to introduce members of the management team of Dollar General and to moderate our fireside chat. DG needs little introduction. It is one of the largest U.S. retailers with almost $30 billion in sales and close to 17,000 stores across the country. Here to discuss the business and the opportunities ahead with me are Todd Vasos, the CEO. Todd joined DG in 2008 during the last recession and became the CEO of the company in 2015. We also have with us today, John Garratt, the CFO of the company. John joined DG in 2014 and became the CFO towards the end of 2015. And finally, we have the COO of DG, Jeff Owen. Jeff returned to DG in 2015 and has been serving as the COO for about a year now. Team, welcome, and thank you for joining us today. I will now hand it over to Donny Lau, Vice President of IR and Corporate Strategy.

Thank you, Chandni. Today's comments will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which can be identified because they are not limited to statements of historical fact. Such statements include, but they are not limited to, statements about our strategy, plans, initiatives, goals, financial outlook or beliefs about future matters, including, but not limited to, beliefs about COVID-19 future impact on the economy, our business and our customer. These statements are subject to risks and uncertainties that could cause actual results or events to differ materially from our expectations and projections. These factors include, but are not limited to, those identified under forward-looking statements in our earnings release issued August 27, 2020, under Risk Factors in our 2019 Form 10-K filed on March 19, 2020, and in our Form 10-Q filed on August 27, 2020, and in the comments that are made during this event. You should not unduly rely on forward-looking statements, which speak only as of today's date. Dollar General disclaims any obligation to update or revise any information discussed today, unless required by law. We may also reference certain financial measures that have not been derived in accordance with GAAP. Reconciliations to the most comparable GAAP measures are included in our earnings release issued on August 27, 2020, which can be found at investor.dollargeneral.com under News & Events. Now it's my pleasure to turn the event over to Chandni, Todd, Jeff and John.

Thank you, Donny. Once again, welcome team. If I could start with the big picture. You guys obviously have also the consumer with your 16,000 plus stores acting as a checkpoint. What do you feel about the health of consumer right now, especially when we consider that 2Q was obviously very strong for you, but is there a way to parse out more trends versus the impetus that the business got from fiscal support?

Yes. Thank you for the question. As you think about our core customer, and prior to COVID, she was probably in the best financial shape she had been in, well, in the 12 years that I've been here. And I would tell you that she had a little bit of money in her pocket. She was back to work. In many cases, working more than 40 hours a week if she wanted to and had the ability to do so. COVID-19 hit, and then obviously, things changed a little bit. But the great thing is that core consumer had still money in her pocket. So she was able to do a nice stock up to get her home ready, like most Americans were doing in the face of COVID. And as we move through the next coming months, stimulus helped our core consumer, obviously, in the middle of the summer. And obviously, even today, as we look where the consumer is and up to the August time frame that we announced during our second quarter earnings call, the consumer was still -- while she wasn't in stock-up mode any longer, she still is in somewhat of a replenishment mode, meaning that she uses it in her home, she's replenishing it that same week. And so we're still seeing that phenomenon. The great thing is, what we've also seen is a good trade down customer. And with that, we saw that our core customer and trade down customers that were coming into the brand, actually bought a lot of our nonconsumable areas, too. So discretionary areas did very well, not only seasonal, but all the way through home and apparel. And so we're cautiously optimistic. Our core consumer always struggles, right? She -- while this is the best she's been, at least going into COVID financially, but that's still saying that she does struggle, and she's continued to struggle through COVID-19. We'll have to continue to monitor this as we look at what stimulus will or won't do as we continue to move through the back half of the year. But we're optimistic with what we've seen at least up to that August time frame so far.

That's very helpful. And if I may dig deeper into your 2Q results. So just wondering about traffic. What drove traffic to decline in the second quarter, especially as you had traffic contribute positively to comps in your 1Q results? And just trying to understand that with respect to lockdown measures that obviously eased throughout the second quarter, how should we contextualize that negative traffic versus, say, new customer acquisition that you also talked about and market share gains that you talked about during your 2Q results?

Yes. Another great question. I mean as you look at it, Q1, we had a positive traffic number. Q2, slightly negative low single digits. And I would tell you that as you look at that low single-digit number, it was probably one of the better performances across consumable retail that was out there. And what I attribute that to, quite frankly, is a couple of things. One, our core customer, for the most part, they are frontline workers. So they continue to be gainfully employed through COVID. So that's one of the reasons. But trip consolidation, obviously, is playing the main factor of this traffic consolidation. But when you think about our better performance that consumer of ours continues to be gainfully employed, again, for the most part. And then the trade down effect, I think, was the other big one that I'm sure is not lost on most folks, surely not for us. We saw that trade down come in, started in that April time frame and really has stuck with us up until and including where we are today. So as we continue to watch that, we can see it through our credit card data and through our proprietary -- talking to our consumers, our proprietary information that we have, that consumer is a little bit more affluent. So she has a little bit more household income. She is a younger consumer with family and much more digitally savvy than our core consumer. So when you look at all that, a lot of our initiatives, which we'll talk about, I'm sure, shortly, really resonate with that consumer. And what we've seen in our data and that credit card data is that trade down consumer has come in multiple times since that April time frame. So what that shows us is she likes what she has seen. And she continues to come in and not only looking for those items that she needs for a household, but shopping that discretionary side very nicely as well. So great to see.

That's very helpful, and that's a good segue into sort of my next question because you talked about basically a more digitally savvy customer. So if perhaps we could talk about your omnichannel efforts. You guys basically accelerated your BOPIS offering at a remarkable pace. And from a mere handful of stores at the end of 1Q to pretty much the entire chain you guys talked about that you will have by the end of 3Q. So as we think about omnichannel in the context of your stores, do you think that absence of an omnichannel offering deterred your customers or any newer customers to come to you in the reality where physical distancing is likely to be an ongoing concern beyond the near term? And are there other omnichannel offerings that you're thinking about?

Yes. Another great question. As you think about it, I think it's just the opposite. I believe that our small box format, conveniently located, 75% of America lives within 5 miles of a Dollar General store, 7,400 square feet, so very easy to park and traverse the store. Not a lot of customers at any given time in the store, so she feels comfortable in that social distancing realm that we're in. So I believe it was a competitive advantage during this time. It's a competitive advantage for us without COVID, but I think it really became a competitive advantage during COVID and still is. And as we think about the omnichannel piece, our core consumer is a fast follower. And we study her very closely, as you know, probably know that customer better than most retailers know their customer base. And I would tell you that our core consumer, while starting her digital journey, is still behind the curve somewhat from where the rest of America is. In saying that, she has told us she wants more convenience in her digital shopping realm as well as still that great value that we offer. And contactless is becoming more important. So with that and even well before COVID hit, customer was telling us this. We started on our journey way back a few years ago on digital coupons, right? And that was really our entry into the digital world. We -- next to COVID, we were actually the second retailer by weeks to launch digital coupons. So we are on the forefront of that. And then obviously, we started to work on our DG GO! app, where you can come in and just scan items, check out on your mobile phone and walk out of the store with no contact at all, which we've now got up and running in hundreds of stores. And as we roll self-checkout, that will be the component of self-checkout eventually for the majority of our stores. And then as you step back from that, obviously, cart calculator, different digital means to help the consumers save money and time as well as then BOPUS, right, buy online, pick up in the store, or DG Pickup as we like to refer to it as. We are happy to announce that we're over 16,000 stores now up and running with just a few 100 stores left to go to be full chain rollout, buy online, pickup in the store. And so far, so good. Our consumers love it. And then even more so, our new consumer base, this trade down customer really loves it. So I think we've hit a home run here. Time will tell. We've got a little time yet to continue to run water through the pipes, if you will, to make sure everything is running well. But so far, so good there, and we'll continue to monitor that. And then as you look into the future, we're always looking down the road and around the corner. And where our next venture will be in digital, the consumer will take us is how we look at it. And the consumer right now, e-commerce delivered to home is not that important to her. But in saying that, we know that one day that may be. So obviously, we're working on things now behind the scenes to ensure that we're ready for her when she's ready to launch her e-commerce journey, if you will. But we always like to say here at Dollar General, we're going to take her along that journey. So as she thinks digital and as she thinks e-commerce, she thinks Dollar General first.

That's great. If I may switch gears to basically unit growth. So you've often talked about DG as a mature retailer in growth mode. As we think about your unit growth opportunity, how do you view it in a post-pandemic world? How you think about your long-term store capacity target? Do you see it changing from where you were, what you thought about it pre-pandemic? And where does your small format stand in all this?

Chandni, this is Jeff. I think I'd say we're very excited about our pipeline and the opportunities to expand Dollar General, nothing's really changed there. We still believe we've got 12,000 opportunities available. Of course, those are available to everybody. And I doesn't say we'll get every one of them, but I think our track record has said that we will get more than our fair share. And we're real pleased with the fact that our real estate model is very sound. We have very, very good tools and technology around market planning to respond to different demographic shifts. And the team really does a nice job of responding and really being nimble to how the things are changing. We're pleased with our pipeline this year, which will prepare us well for the future. But right now, we think that pre-pandemic and post-pandemic, we believe Dollar General is as relevant as we've ever been. I think we've talked earlier about the new customers that have come into our model and seen what we have to offer. So certainly, you combine that with the opportunities and our strength in format innovation, I think bodes well for us to be able to serve the communities for the type of store that they need. And you mentioned the smaller format. Our formats go from the DGX, all the way to the DG Market and many in between. And on the DGX front, we've been a few years at this now. And we're real pleased with what we're seeing. We continue to refine that. And we think that there's runway. And when we talk about DGX, what I will say is we believe that there's up to 1,000 opportunities, and those are not included in the 12,000 that I referred to earlier. So we think that the vertical living really responds well to our offering. And we're pleased and we continue to innovate that format. So more to come there. But we feel very good about the future and the ability to expand Dollar General across the country.

That's very helpful. Just sort of sticking with that theme because one of the themes that was discussed widely at the conference yesterday was sort of what real estate opportunities might come out for stronger retailers in the aftermath of the pandemic, be it in the form of rent negotiations or better boxes or perhaps a faster pace of store openings? Any color you could throw on that, on any of those themes would be helpful.

Yes. I mean, I think you've seen us in the past. When opportunities come our way, if you'll recall, a few years ago, we acquired Dollar Express stores. Those 300 stores that allowed us to really enter into more deep urban and really learn more about how we're able to serve that customer. And we're real pleased with the learnings and the performance we've had there. We've also, as you've seen other competitors, when unfortunately, they are not -- are no longer in operation and things come our way, we are able to respond. And I think that goes back to our format innovation. So I think we're able to really be flexible with the opportunities that present themselves. Of course, we're always focused on serving our customer and ensuring that we can get our stores where the customers are wanting them. And certainly, on the returns front, I know John has mentioned many times, we're pleased with the way the stores are performing. So we'll continue to look at things as they come across. But as you know, 1,000 stores this year, we're looking at just about any opportunity. And if things come our way, we'll be happy to look at it. But we feel real good about our strategy of opening stores, and we'll continue to stick to that and look forward to the future.

That's great. I'd like to switch gears to some of your initiatives, starting with DG Fresh. So you obviously accelerated a lot of these initiatives in 2Q and DG Fresh was one of them. How has the performance of your self-distributed stores? How has it differed versus the rest of the chain? And is there an opportunity to introduce more SKUs, whichever way the customer wants to go, and perhaps even more produce in your stores? Any color around that. Any color around any gross margin opportunity versus SG&A investment as you think about DG Fresh, that would be great.

Chandni, I would say this. You obviously -- the way you ticked off some of the benefits, you certainly are familiar with DG Fresh. So I think you've heard us talk in our recent quarter, John mentioned, in terms of our gross margin expansion, DG Fresh is one of the largest contributors to that. And so we certainly are seeing the benefits around our cost of goods and removing that middleman markup, that has certainly been of benefit. So we're very pleased with the performance of DG Fresh, and we expect to be in 14,000 stores by the end of this year. So we are ahead of schedule. And it's hard to believe how fast we've come on this initiative, and we're very excited. So as it goes, we said we would be able to remove costs and improve margins, and that's happening. We also think that there's top line benefit. We're seeing it right now. You've heard us say many times, when you compare the third-party distribution to our dry side, we see about a 10-point differential in the in-stock percentage of the products. So we've always thought there's a big opportunity there, and we're seeing that. And then also recall, we've talked about not only the DG Fresh initiative, but you combine the DG Fresh initiative with the higher capacity coolers that we have also included in many of our stores, which provides us with about 45 -- 40% to 45% more capacity and allows us to handle 25% more items. And so we are adding items. We're doing that already, more items into the assortment. Because remember, with DG Fresh, it now opens up the opportunity for us to source product from many different opportunities. So as an example, we're able to carry the #1 hot dog brand, which we weren't able to do before. And it also opens up the ability to introduce more private brand into our cooler assortment. So we certainly see room to grow there, and we're very pleased. And we'll be able to offer the customer even more than what we've already implemented in the stores we've rolled out. And then we expect to be done with DG Fresh in 2021 and then we'll be able to look at produce, as you mentioned. And as you know, we have produce in a little less than 900 stores right now. So we've been doing that for many years. And it goes back to our DG Market days where we've been learning about produce for quite some time. So now with DG Fresh, it's an unlock. It allows us to continue to improve the margin on the produce side. We like what we see when we put produce in stores. It certainly is responding well to customers. But as we continue to move down this road, we'll see the margin rate accretion that we're looking for. Right now, it's margin dollar accretive. So more to come there, but we feel like, as you can probably tell, DG Fresh unlocks a tremendous amount of opportunity in our stores.

That's great. And switching gears on that similar theme, but sort of switching gears specifically to your supply chain. Besides self-distribution of fresh product, what other opportunities do you see in this area, talking both domestically and internationally? As you think about expanding fresh in your store base next year, how should we think about your distribution network evolving in terms of traditional DCs versus cold storage facilities versus private fleet, if you could perhaps throw some color there.

Yes. I would tell you that we're always looking down the road and around the corner as it relates to everything in the business, including our distribution and transportation networks. And as you think about distribution, we have stood up in the last couple of years with DG Fresh many facilities as we continue to grow that side of the business. We have said from the beginning that about 5 a year to 6 a year feels about right. And so 10 to 12 by the time we get finished with this year. And then obviously, we still have a few more into 2021 on the fresh side. But bigger picture is how do we become now even more efficient. So this year as well and into next, we're going to have a couple of facilities that are our dry facilities today that will actually combine a fresh element to it. So we'll have a combined DC where we're shipping both our dry side and our fresh side out of the same facility, which we believe will unlock a lot of efficiency for us as we continue to go down the road. And as we build new DCs and where those DCs are located on the dry side, if it makes sense, we will be adding the fresh component to that as well. We continue to look overseas as well on how we bring goods over, how we store them overseas and stage them and bring them over. So there's always those opportunities that we continue to watch as well as DCs on this side, where we consolidate goods over in the U.S. So there's a lot of different moving parts that we manage each and every day. But I have to say that our team is very good at stripping out cost as it relates to both distribution as well as that transportation side.

That's very helpful. And sticking with sort of that theme, but just discussing inventory in the back half because that's another theme that just comes out of this conference that a lot of retailers have a lot of inventory constraint going into the back half. So what gives you confidence to manage your in-stock levels as you think about the coming 2 quarters? What categories are seeing bigger constraints for you versus others? And then how do you think about distribution and transportation costs in the back half, especially with the level of elevated volumes we just have in the ecosystem at this point.