UPDATE: Jefferies Cuts Dollar General (DG) to Hold; PT Trimmed to $96
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(Updated - August 15, 2016 7:24 AM EDT)
The firm commented today:
- We see increased risk of stepped up price competition. Our downgrade does not reflect sales concerns around Q2 and our checks suggest SSS should continue to track around recent levels so our estimate is unchanged at +2.5%. However, we did start to see evidence of increased pricing activity from Walmart. We believe DG will want to stay tight with WMT on price and should be able to counter some of this pressure with gross margin initiatives outlined at its analyst meeting, but the question is for how long. WMT is at the beginning of its price investment campaign so that risk considered, shares of DG after a big run look less attractive.
- Valuation has gotten richer. Over the past two years we have raised our price target 5 times and this has included a step-up in our valuation target from 16x to 20x (new target is 19x). We think this has been well deserved as DG has executed well and remained a safe port in a stormy retail environment where many sectors have fallen prey to online competition. We have deep respect for the management team and it appears that many of its initiatives should naturally push gross margin higher, but it seemed to refrain from building too much into the outlook given many some of the unknowns, such as what Walmart and Family Dollar would do on price. That said, some of our optimism earlier this year stemmed from potential upside to gross margin and we are now less sure that will materialize in future quarters. Given our previous valuation target at 20x and our need to stretch it to 21x to support a Buy rating under the Jefferies rating system, we have decided to lower the rating as risk reward looks less attractive at this juncture.
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