Dollar General(NYSE: DG) targets its merchandise to appeal to lower-income customers. There are benefits to this approach, but there are also negatives. Right now, the negatives are overwhelming the positives, evidenced by the 20% year-over-year decline in earnings in the second quarter.
Even worse, the really bad news from the quarter is somewhat hidden. It only becomes apparent after doing a deep dive into the earnings report.
What does Dollar General do?
Dollar General is something like a variety store, selling everything from food basics to clothing and home goods. What differentiates the retailer is that it specifically targets lower-income consumers. Thus, the products it sells are predominantly value-oriented. It furthers this focus by building smaller stores in local communities that are often rural rather than zeroing in on the largest and wealthiest metropolitan areas. It has over 20,000 locations in the United States and Mexico.
There are two positives to consider with Dollar General's business. At its core, the company caters to customers who likely need to shop at a retailer with a value offering. That's a strong foundation. Meanwhile, it can benefit from higher income consumers that trade down for some reason, most likely broader economic uncertainty, such as a recession. That can provide support to the business when times are tough.
Dollar General's core is struggling
Despite the ability to benefit from trade-down customers, Dollar General's core lower-income consumer is still the driving force on the top and bottom lines. Right now the company's foundational customer is under stress. From a big-picture perspective that is showing up in earnings, which were off by 20% year over year in the second quarter of 2024. Earnings were down by nearly 30% in the first quarter of the year. And they fell roughly 29% in 2023.
There's a lot that goes into the earnings figure, including the fact that elevated inflation over the past few years increased the company's cost structure. Clearly, Dollar General is having problems, but this alone doesn't give you a full indication of the headwinds the business is facing. To understand the deeper problem you need to dig into the sales figures a little bit.
Sales were up 4.2% year over year which sounds pretty good. But same-store sales rose only 0.5%, which highlights that new store openings were the main driver of the top line. Same-store sales show how well the company is operating stores that have been open for a year or more. Management said:
[Same-store sales were] driven by an increase in customer traffic, partially offset by a decrease in average transaction amount. Same-store sales in the second quarter of 2024 included growth in the consumables category, partially offset by declines in each of the seasonal, home, and apparel categories.
What does all that mean, particularly when you pair it with a 112-basis-point drop in the company's gross profit margin? First, its customers aren't buying as much each time they go shopping, preferring to shop more frequently. That's a money-saving behavior that hints they can't afford to splurge like they used to. The shift toward consumables, which are necessities, and away from discretionary items like clothing, home decor, and seasonal goods underscores the financial strain.
These same trends were in place in the first quarter and throughout the full year in 2023. And what it means is the company is selling more stuff, but the stuff it is selling isn't as profitable to sell. Sure, the consumables being bought are what get Dollar General's core customers in the door, but if they don't have the money to buy the other, higher margin, items for sale, Dollar General's business will remain under pressure. Opening new locations can hide the impact of this dynamic, but it won't change it.
Dollar General's headwinds will persist until the economy improves
In the first quarter of 2024, Dollar General's same-store sales rose 2.4%, so the 0.5% gain in the second quarter was a drop-off. While a single quarter doesn't make a trend, the underlying weakness of its customers is, indeed, a trend that has been going on for a little while. And until this changes, investors should probably expect relatively poor results from Dollar General.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.