Wednesday, November 4, 2009

Does the Market Still Crave Inferior Goods? Dollar General's Upcoming IPO

Kohlberg Kravis Roberts & Co (NYSE:KFN), recently set terms on a $750 million IPO for their discount retailer, Dollar General (NYSE:DG). If all goes according to plan, 34.1 million shares will sell for between $21 and $23 providing cash which KKR will use to pay down debts. How the market accepts this offering may betray its true feelings towards the economy. As a discount retailer specializing in value goods, Dollar General will only continue to see growth as long as people’s incomes continue to drop. Thus a strong showing at Dollar Generals IPO could indicate the market believes the recession will continue to impact people, in spite of recent positive GDP numbers.

While most businesses have been enduring hard times, discount retailers such as Dollar General and Wal-Mart have enjoyed an economic boon. In-fact, Dollar General has announced it will open 500 new stores and renovate 450 others in their fiscal year 2009. This expansion is bolstered by Dollar General’s strong earnings, in the half year ending July 21st; Dollar General saw net sales increase 13.3% over the same period a year earlier to $5.7 billion, raking in a profit of $176.6 million.

These numbers make sense economically, as one would expect a time of higher unemployment and lower incomes to translate into more business for discount retailers. However, many analysts are announcing the end of the recession due to a GDP increase of 3.5% in the third quarter. If this were true, Dollar General’s expansion would be somewhat unviable. How could one sustain its recent growth if the economic conditions which permitted it were abating? It seems Dollar General is betting that demand for their product will continue for the foreseeable future and thus so will our recessed conditions. If the market receives Dollar General’s IPO well, it would be saying Dollar General is on firm financial grounds, its expansion is on firm financial grounds and therefore the economy is on weak financial grounds.

Conversely, should Dollar General receive good results at the IPO, its individual properties could witness cap rate compression. This would only make sense because, in essence, the company would be receiving a vote of good faith from the market which would be both substantial and measurable, translating into higher prices. The trend has already been towards discount retailers; a strong IPO would confirm this trend for the near future and lend credence to Dollar General as an investment opportunity. The question is whether this spike will renew investor demand for Dollar General real estate interests.

No comments:

Post a Comment