Argus Wants To See Dollar General Open Small-Format Stores

The brokerage said the company's fleet of nearly 12,500 stores differentiate themselves in a crowded retail landscape for providing frequently used items such as milk, cleaning supplies, over-the-counter medicines, beauty aids, snacks and, more recently, tobacco.

"Management's research suggests that substantially more comparable-format stores could be opened in the U.S., utilizing the company's expertise of operating clean, well-stocked stores in small towns and rural markets," analyst Christopher Graja wrote in a note.

Graja expects Dollar General to drive 11 percent compound annual EPS growth over the next five years by opening new stores with a low cost structure and by offering "everyday low" prices.

Related Link: Goldman Goes Neutral On Dollar-Store Space, But likes Dollar Tree

In addition, the analyst said the company could offset margin pressure by managing the mix of consumable and discretionary merchandise, effective promotions and increasing the mix of higher-margin private brands.

That said, Graja cut his FY17 EPS estimate to $4.55 from $4.64, given the increased price competition and deflationary pricing pressures on important perishable products. However, the revised forecast still represents a year-over-year increase of 15 percent. The consensus estimate is $4.52.

Graja also expects a very competitive retail environment to continue, especially from Dollar Tree, Inc. DLTR's acquisition of Family Dollar.

But, the analyst said Dollar General would not be much impacted by the acquisition. Dollar General will continue to open stores organically and repurchase its own shares.

"In our view, DG has the expertise and opportunity to grow organically without the distractions and regulatory issues that could have resulted from acquiring its smaller rival," Graja added.

At time of writing, shares of Dollar General were down 1.8 percent on the day at $72. Dollar Tree was flat on the day at $83.11.

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