Dollar General Corp. (DG:US), the discount retailer acquired by KKR & Co. in 2007, is fetching a premium in the debt markets as it approaches an investment-grade rating and takes market share from Wal-Mart Stores Inc. (WMT:US) and other larger competitors as the economy struggles to accelerate.
Last week Moody’s Investors Service raised its rating on the largest U.S. dollar store chain to its highest speculative- grade level and lenders extended a loan by three years without demanding stricter terms than its existing bank debt. The loan trades at 99.75 cents on the dollar, according to data compiled by Bloomberg, higher than the average of 93.41 in the S&P/LSTA U.S. Leveraged Loan 100 index as of April 13.
“What differentiates this company from other 2007 LBOs is that there’s really no correlation with economic cycles,” Matt Nemer, a San Francisco-based analyst at Wells Fargo Securities, said in a telephone interview. “It’s primarily been a revenue- improvement story.”
Dollar General, which incurred more than $4 billion of debt in the leveraged buyout by KKR at the top of the market, has benefited by the weak recovery from the deepest recession since the Great Depression. Hourly earnings have risen just 1.9 percent on average since the start of 2010, down from 2.7 percent in 2009, 3.2 percent in 2008 and 3.5 percent in 2007, according the Labor Department in Washington.
Dollar General’s same-store sales rose 6 percent in the year ended Feb. 3, after rising 4.9 percent in fiscal 2011, it said in a March 22 regulatory filing. Wal-Mart’s U.S. same-store sales gained 1.6 percent in the year ended Jan. 31, after falling 0.6 percent, it said in a March 27 filing.
Demand for its goods has allowed the Goodlettsville, Tennessee-based chain, which has had 13 straight quarters of net income, to cut long-term debt (DG:US) to $3.6 billion. Moody’s calls the company “relatively resistant to economic cycles.”
Dollar General’s leverage (DG:US), or the ratio of total debt to earnings before interest, taxes, depreciation and amortization fell to 1.48 at the end of its latest year from a high of 11.4 times in its second 2008 quarter.
“We have a less cyclical model than most retailers,” Mary Winn Gordon, vice president of investor relations and public relations, said in an e-mailed statement. “Our belief is that relatively soon we will receive investment grade rating.”
Peanut Butter, Soap
About 73 percent of Dollar General’s 2011 revenue derived from consumables, Gordon said in a telephone interview. The category includes peanut butter, soap, paper towels and aspirin.
Only four of 40 LBOs from the 2006-2008 “bubble era” that Moody’s reviewed in a Dec. 5 report had higher corporate family ratings than when their buyouts closed and didn’t default during that span. Of those, Dollar General showed the most rating improvement, growth and profitability, Moody’s said. Only 10 of the entire sample either produced dividends for sponsors, had IPOs or were sold, according to the ratings company.
“We’re in a macro-environment where people are looking for value, and Dollar General is perfectly positioned for that,” John Heinbockel, an analyst at Guggenheim Securities LLC in New York said in a telephone interview.
The consumables market is growing 4 percent to 5 percent annually, while Dollar General’s sales in the sector have been increasing at low double-digit rates, Heinbockel said.
“There probably aren’t too many companies, if any, growing their consumables business faster,” he said. “Outside of a rare few, I think they’re taking share from just about everybody.”
Dollar General has climbed (DG:US) 13 percent this year on the New York Stock Exchange to $46.30, more than doubling since its 2009 initial public offering. Wal-Mart is up 0.02 percent.
“Wal-Mart’s business strategy is to operate as efficiently as possible with the lowest possible costs,” Greg Rossiter, director of corporate communications, said in a telephone interview.
The Bentonville, Arkansas-based company reported its second consecutive positive period of same-store sales (WMT:US) in the fourth quarter after “strengthening its commitment to its everyday low-price business model” two years ago to better address consumer needs during the recession.
KKR, which owns 31 percent (DG:US) of Dollar General, purchased the company for $7.3 billion in 2007. It has been redeeming bonds and buying back shares from KKR, reducing the New York-based private-equity firm’s controlling interest. Dollar General’s market value (DG:US) at the end of trading on April 13 was $15.4 billion, and its enterprise value, which includes cash holdings and debts owed, was $17.8 billion, Bloomberg data show.
Dollar General generated $213 in net sales per square foot for the year through Feb. 3, up from $201 in fiscal 2010, according to its March 22 filing.
Among operational improvements the company has made were the addition of refrigerated coolers and freezers driving traffic to the stores, Wells Fargo’s Nemer said. Improved check- out technology and raising the height of its shelves to allow more products also contributed.
Moody’s upgraded the company on April 13 to Ba1, one level below investment grade, citing operating performance and credit metrics that are “expected to remain strong.” Net income (DG:US) rose to $766.7 million last year from $627.9 million in fiscal 2011, according to the March 22 filing. Earnings before interest taxes, depreciation and amortization increased to $1.7 billion from $1.5 billion.
“Dollar General is one of the few LBOs that has been able to do a significant amount of delevering, and that’s been a positive testament to its business position,” Maggie Taylor, a senior credit officer at Moody’s, said in a telephone interview. “It’s been a combination of consistent debt repayment and very strong operating performance given new store openings and the economy helping the dollar-store space.”
Moody’s has a “positive” outlook on the debt. S&P rates (DG:US) it an equivalent BB+, also with a “positive” outlook.
“KKR’s stake declining below 50 percent triggers additional board members joining and makes the company more in control of its financial policy rather than being dictated by KKR,” Taylor said. Share repurchases are viewed as credit neutral.
Dollar General, which has 10,000 stores in 39 states, raised $716 million in its initial public offering in November 2009, receiving 67 percent of the proceeds. The money was used to pay down debt.
The retailer extended maturities on its asset-backed credit line last month to July 2014 and increased the maximum borrowing to $1.2 billion. The debt pays interest at 1.75 percentage points more than the London interbank offered rate.
It also extended $879.7 million of its term loan into a new C portion that pays 2.75 percentage points more than the lending benchmark, the same rate it got in 2007, Bloomberg data show.
“The loan rates it gets is positive affirmation of Dollar General’s stellar business model,” Mark Montagna, an analyst at Avondale Partners LLC wrote in an e-mail. “The investment-grade rating matters very little since the debt is already trading as though Dollar General is investment grade,” Montagna said.
Dollar General’s $450 million of variable-rate senior subordinated notes due July 2017 traded April 4 at 108.5 cents on the dollar to yield 9.77 percent, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority. The company intends to refinance the notes in the second or third quarter of 2012, according to Gordon.
“After that, what’s left is fairly low cost,” Heinbockel said about the company’s borrowings. “There’s less benefit to paying down more debt and more benefit from buying back stock or paying a dividend.”
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