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For Dollar General, Tariffs Could Bring New Business

Dollar General Corp. has been diversifying its sourcing for two years, and is now planning its business under the assumption that tariffs are the new normal.

That’s the conclusion from UBS equities analyst Michael Lasser, who recently met with the retailer’s management team.

According to the analyst, the company “believes it’s only been able to do this because it actually started the process two years ago. Notably, the company’s limited [stock keeping unit (SKU)] count gives it a degree of negotiating power that many of its competitors don’t have.”

The dollar chain, Lasser said, “doesn’t need to purchase goods from China” and it can take advantage of deals “from other countries of origin, along with U.S.-sourced deals and close-outs.” Purchasing close-outs and special buys help Dollar General limit its exposure risk to Chinese imports.

“Dollar General is planning its business under the assumption that tariffs are the new normal. Any rollback of tariffs would be incremental to its business,” he said.

The dollar chain appears to be content with its current price positioning, according to Lasser. On average, prices are 44 percent cheaper that the drug store channel, 20 percent lower than grocery stores and “at parity with mass players,” such as Walmart and Target. Given the retailer’s comfort levels with its current price points, Dollar General is “more likely to let margin benefits from other areas fall through to the bottom line as opposed to investing in lower prices.”

As for how the dollar chain is working with its vendors on the sourcing front, John Garratt, chief financial officer told investors on a conference call last month, after the company posted second-quarter earnings, that the “teams have been diligently working to mitigate the impact of tariffs on our customers and our business.” The efforts, he said, are focused on four key areas that include ongoing negotiations with vendors, product substitutions, product re-engineering and country of origin diversification.

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“We intend to continue these efforts to do all we can to minimize the impact to our customers and remain focused on our everyday low-price strategy to provide our customers with the value they need and have come to expect from Dollar General,” Garratt said.

The retailer’s chief executive officer Todd Vasos told investors during the call that tariff impact mitigation is at the forefront of the company’s merchandising efforts, with foreign sourcing remaining a long-term gross margin opportunity.

“Our goals include increasing penetration as well as diversifying countries from which we source,” the CEO said, noting that the company has already reduced its sourcing exposure to China by 7 percent in the current fiscal year.”

The move to source outside of China has been underway for months, and the company has seen some success in other parts of the world.

“The great thing is, we’ve had boosts on the ground in Mexico, Vietnam, Cambodia and many other Southeast Asian countries, including India as well, for many, many years and so we’re just leveraging that capability to an even great time right now with these tariffs and the uncertainty around those,” Vasos said.

Dollar General’s management team, the CEO said, remains “focused on disciplined cost control.” The quarter’s comps were driven by “strong performance in both consumables and non-consumables sales. Our non-consumable sales growth was driven by positive results in seasonal and in home.” Since last year, the company has expanded its assortment in the non-consumables categories, which now includes home domestics, housewares and occasion.

For the quarter ended Aug. 2, net income rose 4.7 percent to $426.6 million, or $1.65 a diluted share, from $407.2 million, or $1.52, for the three months ended Aug. 2. Net sales were up 8.4 percent to $6.98 billion from $6.44 billion, with same-store sales up 4 percent.

While those are good results, what’s perhaps more interesting is Lasser’s conclusion that the fastest growing customer segment for Dollar General is households with annual income of over $50,000. He believes a better merchandising assortment has played a role, as well as the offering of what is perceived as better value.

“This appeals to customers from slightly higher income brackets. We think that offering good value is part of Dollar General’s secret sauce. The $50K-earning customer is still predominantly female, but it skews younger, This customer tends to be in the upper 30s to 55 range, in comparison to the core customer who is in the mid-40s to 60s. Dollar General is also seeing an influx of millennial customers. This customer tends to be tech savvy [and] Dollar General is doing more of its messaging over the internet and through mobile devices. This is helping [them] attract slightly higher income customers,” Lasser said. That would give the retailer potentially larger basket sizes over time and, more importantly, ensures that the dollar chain will have “new cohorts of customers.”

Also helping Dollar General are its partnerships with FedEx and Western Union, which are driving incremental traffic to its stores. For example, most Western Union locations typically average 15 to 20 miles away from their customers, Lasser noted, so the convenience of killing both birds with one visit has proved a win.

Separately, Dollar General said Monday that it will open three new stores in early fiscal 2020.

The new stores–in Centralia, Washington; Cathlamet, Washington, and Pine Bluffs, Wyoming–are currently under construction. When fully opened, the new stores will expand Dollar General’s presence to 46 states across the U.S. Dollar General currently operates 16,000 retail locations. The stores are what the company refers to as its “easy-to-shop, small box format,” with each door employing between six to 10 employees. The company opened 489 new stores in the first half of the current fiscal year.