Snacks and cleaning supplies aren’t the only thing on sale at Dollar General Corporation (NYSE:DG).
Last week, shares of the discount retailer fell to their lowest level since May 2019 following a dreadful second quarter earnings report. Like a bottle of generic bleach, the move erased all of the stock’s post-pandemic gains and put it $135, or 51%, below its 2022 record peak.
Dollar General announced that Q2 profits were down 29% year-over-year, much worse than the 17% decline that Wall Street anticipated. The underperformance was attributed to several factors, including 1) the impact of higher gas prices on consumer spending, 2) reduced government Supplemental Nutrition Assistance Program (SNAP) benefits and 3) lower income tax refunds.
Management created more investor panic when it lowered its full-year profit outlook for the second time. It now sees 2023 earnings per share (EPS) declining as much as 34% from last year — a sharp contrast to 2021, when profits soared 58%.
Given the big miss and weakened outlook, avoiding Dollar General at all costs would seem like the thing to do. Then again, maybe not. A closer look reveals an attractive long-term play on a consumer spending rebound.
#1 - Dollar General's Troubles Are Not Company-Specific
The common denominator in the Q2 profit shortfall is that American consumers are still feeling the heat. This is especially true for Dollar General’s lower-income customers who are having to cut or eliminate discretionary purchases to make room for essentials like food and household supplies. The reasons cited by management are only part of the problem. Even moderating inflation combined with elevated interest rates are taking a bite out of consumer purchasing power.
It is an issue that is not unique to Dollar General. Dollar Tree, Target, Walmart and other value-oriented stores are struggling with the same phenomenon. Making matters worse, organized theft, a problem hurting a wide range of retailers, is having a disproportionate impact on lower-margin discount chains.
The macroeconomic and ‘shrink’ headwinds aren’t going away overnight, but misery loves company. The retail industry as a whole will find a way to get through this rough discretionary spending patch. Hard-to-resist promotions, cost reductions and new theft deterrents are all likely to be part of the solution. These will act as Band-Aids until inflation and rate pressures subside and consumers have more wiggle room. Dollar General is facing industry wide constraints. This is a better situation than a damaged brand reputation, accounting scandal or some other company-specific issue.
#2 - There Are Silver Linings to the Story
CEO Jeffrey Owen’s honest assessment of business conditions included some positive developments that got brushed aside by the market. In Q2, the company gained market share in both the consumable and non-consumable product categories. This is no small feat considering how the tough economic environment has made retail competition extra fierce. It also shows that consumers continue to ‘trade-down’ from grocery and big box stores to Dollar General. This probably won’t last in a healthier economic setting, but it could lead to more brand awareness and customers over time.
Meanwhile, Dollar General is positioning itself to grab more market share on the other side of the slowdown by moving forward with growth. The company plans to open nearly 1,000 new U.S. locations and complete 2,000 remodels this year in addition to around 20 store openings in a recovering Mexico.
Its most intriguing growth initiative, though is the pOpshelf concept. The smaller format stores designed to attract the value-conscious affluent are ‘popping’ up nationwide and are on pace to reach 90 locations by year-end. Success with this endeavor stands to reduce Dollar General’s dependence on less wealthy households and improve sales growth.
#3 - DG Offers Significant Value
Just as Dollar General stores are a strong value proposition for cash-strapped shoppers, its shares offer significant value for patient investors. An underappreciated aspect of the stock is the $1.4 billion left on the current buyback authorization. Management has expressed a commitment to putting excess cash toward share repurchases. When it does, this will lower the outstanding share count and increase EPS.
Even without the buyback effects, the stock is attractively valued. The midpoint of the revised 2023 EPS guidance gives DG a P/E ratio of 16.5x. This represents a 22% discount to the stock’s five-year average P/E. It also makes it cheap relative to consumer staples retail peers like Costco (39x) , Walmart (25x) and, yes, Dollar Tree (20x).
Dollar General’s value goes one step further — the dividend. With the latest drop in share price, the dividend yield is up to 1.9%. This is on par with the sector average but compelling for two reasons: 1) DG has raised its dividend for seven consecutive years and 2) with less than 30% of profits going towards dividends, there is significant headroom for more hikes.