Bernstein Calls Dollar General 'Our Strategic Winner,' Attractive Takeover Target For Amazon

Bernstein maintains its Outperform rating on Dollar General Corp. DG, saying the stock offers good value as the declining middle class and shrinking household size should offset short term pricing pressures.

Further, the brokerage also called Dollar General as an attractive acquisition target for Amazon.com, Inc. AMZN, a potential move that could solve the online retail giant’s problem of last mile connectivity.

“We believe Dollar General is a well-managed strategic winner with wide open rural markets easily absorbing 1000 more stores a year,” analyst Brandon Fletcher wrote in a note.

Fletcher pointed out Dollar General’s strength in rural markets and noted that earnings rose 7 percent from just store growth with almost a decade of growth left to fill the 10,000 open rural spots.

Looking Forward

Fletcher expects the store growth and continued operational discipline could yield an EPS CAGR of 12 percent (FY 2016–2020) and grow cash flow for another 20 years.

Investors are concerned over poor comps that masked the “blazing growth” of nearly 1,000 new stores. But, Fletcher says the comps will stabilize, as he believes Wal-Mart Stores Inc WMT’s price action to moderate by the first quarter, while lower income households adjustment to SNAP changes should benefit comps.

Why An M&A Would Be Attractive

As such, Fletcher believes Dollar General could be an attractive acquisition target for Amazon with national ‘ship point’ footprint.

“The DG footprint is useful as a national ‘ship point’ footprint for AMZN. DG is already close to most homes so 'final mile' can be solved more easily. DG stores have loading docks and back room capacity to help merge online orders with food & consumables,” Fletcher elaborated.

In fact, the analyst said Dollar General has a format that is not at genuine risk of disruption from Amazon or any other structural shift. Most of Dollar General stores do not face a Walmart in the same city and modular construction has kept costs to 250,000 per building.

“[U]ltra-rural ‘crossroads’ locations are more convenient by many miles than the nearest Walmart, or Family Dollar. These boxes sell less per square foot, but all input costs are lower so IRR is right in line,” Fletcher highlighted.

Wall Street is not considering rural as a meaningful market both in terms of population and in terms of income. However, strong farming incomes are reversing the trend.

“These crossroad stores are needed, are profitable and are not 'Amazonable' until bought by AMZN,” Fletcher added.

At last check, shares of Dollar General fell 1.62 percent to $76.43. Fletcher has a price target of $91, implying potential upside of 19 percent over the current levels.