Discount-Variety Stores IndustryModule 3- Market Multiple Valuation

Kate Johnson

“Save Time. Save Money.”

• Largest discount retailer in the US by number of stores

• Goodlettsville, Tennessee• 11,000 stores• 40 States• Southern, Southwestern,

Midwestern, Eastern US• Merchandise is typically $10

or less• Founded in 1939• Stock publicly traded in 2009

Product Types

• Two brands: 1)High quality national brands from leading manufacturers 2)Comparable quality private brand selections10,000 SKUS/store10$ or less

How are they profitable?• Convenient Locations• Time Saving Shopping Experience• Everyday Low Prices on Quality Merchandise• Key items in a broad range of general merchandise categories • Most basic shopping needs are met in one trip

Steps to Using MultiplesStep 1: Select relevant summary measures

Step 2: Identify comparable companies to use in determining the market multiple

Step 3: Compute the market multiple (ratio) from the comparable companies• Step 4: Compute the DG’s value using its performance measure and the

market multiple• Step 5: Performance measure is:

- enterprise performance measure subtract value owed to debt holders and divide by shares outstanding to get equity value per share

-equity measure divide• Focusing on enterprise values so that capital structure isn’t carefully

considered

Step 1 Select the summary performance measures to use as the basis for valuation

• EPAT• NEA• EPAT from Sales• Sales Per Square Foot• Why this selection?• One B/S multiple two I/S multiples, one

industry specific multiple (sales per square foot most often used in retail industry)

Step 2: Identify Comparable Companies

Note: Costco is removed for sensitivity analysis

Identify comparable companies to use in determining the market multiple

But DG is a Dollar Store?• Dollar General is more suited to be compared with Walmart, Target, and

Costco, as not everything is $1 (DLTR) and they have produce (unlike FDO)• Characteristics such as industry and size are often chosen for comparable

Select the comparable companies to use in determining the market multiple

Notes

• Market multiple valuation is a method not a model

• Different industries should use different measures

• Presumes target company not fairly valued• No correct answer to “how we produce the

multiple”

Step 3: Computing MultiplesCompute the market multiple from the comparable companies’ market values and performance measures

Estimating value: EPAT Multiple

Estimating value: NEA Multiple

Estimating value: EPAT from Sales Multiple

Profit Multiple

Sales per Square Foot Multiple

Focuses on sales not total revenue

Buy, Sell or Hold?

Buy, Sell, or Hold?

Valuation using EPAT multiple: Sell, SellValuation using NEA multiple: Sell, Sell

Valuation using EPAT from sales: Sell, SellValuation using sales per square foot: Buy, Hold

Dilemma: One suggests Dollar General is undervaluedSensitivity analysis suggests Dollar General is overvalued

Issues

• Different year ends for each company

• Sales per square foot doesn’t take into account online sales

• Sales per square foot calculations are based on total square foot of all stores and total sales- info may be skewed?

• Dollar General the outcast in many respects (especially size) (although is extremely competitive regarding gross margin)

Can we exclude Walmart?

Walmart is considered a leading competitor to DG!

Yet, Walmart has almost double the amount of sales per square foot!

Excluding Walmart

Removing Walmart suggests perhaps we should sell the stock, not buy!Decision: Exclude, overall we should sell the stock as it is overvalued.

Average of estimates decreases when Walmart is removed!

Evaluating Results

• Subjective measure that requires one to make assumptions and judgment

• No right judgment makes it difficult• No one measure is the right one to use• Market multiples popular due to simplicity • Place to start, “first-pass, parsimonious

indicator of value”