Acquisitions can be a sure-fire way to supercharge growth. But when a major buyout attempt falls through, prospects for rapid expansion may suddenly look slim.

 

#-ad_banner-#At first glance, that may characterize the outlook for discount merchandiser Dollar General Corp. (NYSE: DG).

 

On further inspection, this retailer has ample room for organic growth. DG hoped to acquire rival Family Dollar Stores, Inc. (NYSE: FDO), but was outbid by Dollar Tree, Inc. (NASDAQ: DLTR). With the competitive landscape now altered, Dollar General now has further incentive to accelerate its growth plans.

 

Dollar Tree will be a pretty even match for Dollar General once the Family Dollar acquisition closes next month. At that point, Dollar Tree will have as many as 12,700 locations and annual revenue of about $18 billion, compared with a pro forma 11,700 stores and $18.5 billion in sales for Dollar General. This includes the roughly 300-to-500 stores Dollar Tree will have to divest to appease antitrust regulators.

 

But even without Family Dollar in the fold, Dollar General could eventually boost its store count by 14,000, more than doubling its current footprint. This expansion goal is feasible because smaller stores (the kind Dollar General typically operates) are relatively inexpensive to open, according to Morningstar analysts. Start-up costs on such stores are also recouped in short order, which should allow Dollar General “to reinvest its cash flow in store growth and sustain mid- to high-single-digit growth rates over the next decade,” analysts wrote.

 

Dollar General opened roughly 700 new locations in 2014, with plans to open 730 new locations this year. Another 875 stores will be remodeled, according to management.

 

Analysts say Dollar General might also pursue smaller acquisitions, though it has avoided deal-making in the past. Indeed, had it worked out, the Family Dollar buyout would have been Dollar General’s first acquisition in about three decades.

 

The past couple years have seen several new measures aimed at increasing customer traffic. An especially potent one: the addition of tobacco products to Dollar General’s product mix in mid-2013.

 

The move has helped drive solid growth in same-store sales, a key retail industry performance metric that only includes established locations that have been open for more than a year.

 

In Dollar General’s case, tobacco products are augmenting same-store sales by luring more smokers, many of whom initially look to buy cigarettes, but then become regular customers that also purchase non-tobacco items. Lately, some of this new business is likely from customers who formerly bought tobacco products from CVS Health Corp. (NYSE: CVS), which ceased tobacco sales last October to better position itself as a health and wellness company.

 

In the third quarter of 2014, Dollar General’s same-store sales growth accelerated to nearly 3% after rising 1.5% and 2.1%, respectively, in the first two quarters of the year. Thanks to greater store traffic during the holidays, management expects to report a fourth-quarter spike in same-store sales of 5%.

 

To stimulate sales across its customer base, Dollar General plans to continue promoting targeted digital coupons, in a program introduced last summer. After enrolling in the program (either online or on their smartphone), customers receive an array of discounts tailored to their profiles. Besides helping to create more loyal shoppers, the program keeps Dollar General abreast of customer preferences so it can alter its product mix accordingly.

 

In keeping with the company’s established strategy for preserving margins, sales growth should increasingly come from higher-margin private-label consumables. That includes items such as paper products, cleaning supplies and packaged food sold under the Smart & Simple brand. Because they’re typically priced lower than competitors, private-label consumables should continue to appeal to lower-income consumers with annual household earnings of less than $25,000, a group that makes up 37% of Dollar General’s customer base.

 

Recent efforts to enhance margins also include offering more kitchen supplies, apparel and other non-consumable products. These typically carry higher margins than consumables, which have historically accounted for more than 70% of Dollar General’s total revenue.

 

Margin-boosting efforts are clearly paying off. As the following table shows, the gross, operating and net margins have all strengthened substantially in the past decade, including during the recession.

	2005	2006	2007	2008	2009	2010	2011	2012	2013	2014	Past 12 months
Gross	29.5	28.7	25.8	27.8	29.3	31.3	32.0	31.7	31.7	31.1	30.7
Operating	7.3	6.5	2.7	2.7	5.6	8.1	9.8	10.1	10.3	9.9	9.4
Net	4.5	4.1	1.5	0.1	1.0	8.1	4.8	5.2	6.0	5.9	5.6

 

Risks To Consider: Retaining market share could get much tougher as retail giants Wal-Mart Stores, Inc. (NYSE: WMT) and Target Corp. (NYSE: TGT) continue to open their own smaller-store formats to compete directly with discount merchandisers like Dollar General. Wal-Mart currently has about 700 such stores and Target has roughly a dozen.

 

Action To Take –> Although a victory in the bidding war for Family Dollar would have been great for Dollar General, the company still has fine prospects for robust organic growth. With competition set to heat up, the 20%-a-year bottom-line expansion it posted during the past five years is likely a thing of the past. However, the 13% growth rate projected by the two dozen analysts covering the stock is feasible.

 

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