Dollar General was one of the stock market's big pandemic beneficiaries. 2 investments banks lay out the bull and bear case for the stock, and how to trade it in the post-pandemic economy.

• As the pandemic set in, Dollar General boomed thanks to its low prices and essential status.
• Now the economy is mending, and investors don’t know if Dollar General can continue to outperform.
• Bank of America analysts have outlined the bear case against Dollar General, while UBS is bullish.
• See more stories on Insider’s business page.

As the pandemic set in during the first quarter of 2020, it became apparent that brick-and-mortar retailers were in serious trouble. Scared customers began to tighten their purse strings, focusing their spending on essential items. The result was a historic decline in real personal consumption expenditures, or PCE, a measurement of consumer spending. 

In the first quarter of 2020, as the pandemic was beginning to flare up around the globe, PCE declined 6.9% quarter-over-quarter — the biggest drop since 1980. By the second quarter, PCE was down a never-before-seen 33.2%. 

As spending dried up, it became clear that Dollar General would emerge as one of the few consumer retail brands to actually excel in the midst of the pandemic. The essential retailer was perfectly positioned to capture consumers looking to cut costs, and Dollar General’s quarterly results from the depth of the pandemic show that it did just that.

In the company’s fiscal first quarter of 2020 (from February to May), Dollar General reported that net sales rose 27.6%, operating profit increased 69.2%, and earnings per share grew a whopping 73% compared to the same period a year earlier. 

The rest of the year saw Dollar General continue to report exceptional quarterly earnings, and when the company announced annual results in March it was clear that Dollar General had done far better than many of its retail competitors. Fiscal year net sales increased 21.6%, operating profit was up 54.4% for the year, and fiscal year diluted EPS had risen 59.9%. 

Now, though, the economy is recovering. Essential businesses are no longer the only ones allowed to serve customers, people are regaining a sense of normalcy, and PCE rose 10.7% in the first quarter. While all of that means great things for the US economy as a whole, suddenly Dollar General’s future is in question.

The bull case

The discount retailer made huge strides over the past year and its stock gained 35% in 2020, more than double the S&P 500. But as the pandemic winds down there’s some disagreement about how Dollar General will perform moving forward. Arguing for the bulls is a team of UBS analysts led by Mark Carden, who wrote that dollar stores such as Dollar General and Dollar Tree have plenty of room to run in the years to come.

The team at UBS admits that Dollar General is facing extremely difficult year-over-year quarterly comparisons given how well last year went, but they see a lot of upside for the company thanks to several new business initiatives. The analysts think that Dollar General’s Non-Consumables Initiative, which focuses on things like houseware and homegoods, and DG Fresh, which includes fresh and frozen groceries, will continue to boost the company’s bottom line. It’s even rolling out a new store concept called Popshelf to capture more elusive suburban millennial customers. 

In addition, while inflation may have investors worried, it might actually be a good thing for Dollar General. After all, for customers who want to stretch their money Dollar General offers an excellent way for them to get more bang for their buck. 

Strong business prospects and favorable macroeconomic conditions are enough for UBS analysts to put a $245 price target on Dollar General shares, a nearly 25% upside from where the stock stands today.

The bear case

But the analysts at Bank of America are less positive that Dollar General can keep its hot streak alive. 

In a note released a day after UBS published their Dollar General guidance, Bank of America analysts Robert Ohmes and Molly Baum downgraded the discount retailer to Underperform.

The analysts presented a number of reasons for their bearish beliefs, including historical data illustrating that as gas prices rise, customers will have less money to spend at Dollar General locations. 

Another macroeconomic factor to consider is wage growth. As retailers struggle to find new employees, many have begun to offer incentives for simply interviewing. The Bank of America analysts believe that wages will increase at competitors like Walmart, while companies like Costco with higher wages already in place will become more appealing to prospective employees, putting pressure on Dollar General to do the same. 

Speaking of competition, Ohmes and Baum pointed out that as the economy reopens Dollar General will face a sudden surge of pressure on its top line.

Grocery stores will begin to offer more promotions this year to get customers back in stores, which will bring them into direct competition with Dollar General’s everyday low price offerings. Competitors with in-store pharmacies have also begun to attract more customers recently, and ad-hoc purchases as people pick up their prescriptions means fewer purchases made at Dollar General locations. 

But the trend that may end up having the greatest detrimental effect on Dollar General’s business is online grocery retail. According to the analysts, grocers with higher online penetration like Walmart and Target that have spent the past year streamlining their in-store pickup and delivery operations have an inherent advantage over Dollar General. Dollar General just can’t compete with the bigger players in the online arena, and the increasing number of low income customers — like those who usually shop at Dollar General — who are beginning to shop for groceries online has the analysts worried.

Finally, while Dollar General’s business has enjoyed incredible success over the last year its stock price has appreciated in lock step. Shares of the company are up 10% in the last twelve months, and now Dollar General is trading well above both its 10-year average P/E and its 10-year average EPS. 

The Bank of America analysts believe that these heightened valuations make Dollar General vulnerable to a significant selloff should the market take a turn for the worse. Shares are already down over 6% year-to-date, and given the difficult comparisons to last year it wouldn’t surprise the Bank of America team to see some serious P/E compression.

Those half dozen reasons are enough for the Bank of America analysts to lower their price objective from $225 to $190, a few dollars below where Dollar General sits today. That’s a far cry from the UBS team’s target of $245, and  investors will have a chance to decide who’s analysis is more accurate when Dollar General reports earnings on May 27. 

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