Stock Analysis

A Look At The Intrinsic Value Of Dollar General Corporation (NYSE:DG)

NYSE:DG
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Key Insights

  • Dollar General's estimated fair value is US$192 based on 2 Stage Free Cash Flow to Equity
  • With US$166 share price, Dollar General appears to be trading close to its estimated fair value
  • Analyst price target for DG is US$200, which is 4.2% above our fair value estimate

In this article we are going to estimate the intrinsic value of Dollar General Corporation (NYSE:DG) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Dollar General

Is Dollar General Fairly Valued?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$1.42b US$702.5m US$1.53b US$1.74b US$2.25b US$2.43b US$2.56b US$2.67b US$2.77b US$2.86b
Growth Rate Estimate Source Analyst x5 Analyst x2 Analyst x4 Analyst x3 Analyst x2 Analyst x2 Est @ 5.38% Est @ 4.40% Est @ 3.71% Est @ 3.23%
Present Value ($, Millions) Discounted @ 7.2% US$1.3k US$611 US$1.2k US$1.3k US$1.6k US$1.6k US$1.6k US$1.5k US$1.5k US$1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$2.9b× (1 + 2.1%) ÷ (7.2%– 2.1%) = US$57b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$57b÷ ( 1 + 7.2%)10= US$28b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$42b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$166, the company appears about fair value at a 13% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NYSE:DG Discounted Cash Flow June 5th 2023

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Dollar General as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.2%, which is based on a levered beta of 0.862. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Dollar General

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
Weakness
  • Earnings growth over the past year is below its 5-year average.
  • Dividend is low compared to the top 25% of dividend payers in the Consumer Retailing market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Dividends are not covered by cash flow.
  • Annual earnings are forecast to grow slower than the American market.

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Dollar General, we've put together three further items you should look at:

  1. Risks: Every company has them, and we've spotted 1 warning sign for Dollar General you should know about.
  2. Future Earnings: How does DG's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Valuation is complex, but we're helping make it simple.

Find out whether Dollar General is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.