Dollar General (NYSE: DG) is one of the most important retailers in the country.
The discount chain can be found in rural communities and other underserved markets, meaning it fills a unique need across much of the country. In fact, Dollar General has by far the most locations of any retail banner with over 20,000 stores across the U.S. and Mexico
Its massive network of stores and leading position in discount retail fueled the stock's rise for years, but that's changed in the wake of the pandemic. Inflation has impacted its customer base, hurting sales growth and profits. As a result, the stock is now down 69% from the peak it reached just a few years ago.
This presents investors with quite the opportunity.
Image source: Getty Images.
Dollar General's woes
Shares of the discount retailer plunged following its second-quarter earnings report as the company came up short of expectations on the top and bottom lines.
Same-store sales rose 0.5%, supporting revenue's 4.2% year-over-year growth to $10.21 billion, which fell short of estimates at $10.37 billion. Gross margin slipped from 31.1% a year ago to 30.0%, and selling, general, and administrative (SG&A) expenses rose about 60 basis points as a percentage of revenue to 24.6%.
As a result, operating profit fell 21% year over year to $550 million, and earnings per share (EPS) declined 20% to $1.70, below the consensus at $1.79. Management also slashed its guidance for fiscal 2024.
Management blamed the weak performance on customers being "financially constrained," and there's some validity to that. Peers like Dollar Tree have also faced similar headwinds and complained about weak consumer demand as have a wide range of other companies, including Target, Ross Stores, and several specialty retailers.
Wall Street is concerned Dollar General is struggling to compete with Walmart, which has thrived in recent years thanks to its strong grocery business and omnichannel investments like online-grocery pickup.
However, competitive weakness doesn't fully explain Dollar General's struggles. For instance, its growth was strongest in consumables, the least discretionary category of merchandise it sells. In its fiscal Q2, consumable sales rose 6% to $8.40 billion, but the company saw declines in other categories, including seasonal, home products, and apparel, categories that generally represent non-essentials.
Management also noted sales were weakest at the end of the month, a sign that customers were struggling to stretch their budgets.
Sixty percent of Dollar General's sales come from households earning less than $35,000 a year, meaning its customers are especially sensitive to higher prices and economic challenges. That's a key difference between Dollar General and Walmart, whose average customer has a household income of $53,000.
Why Dollar General is a buy
The challenging market conditions won't last forever. Inflation has already fallen back toward the Federal Reserve's goal of 2%, and the central bank has begun lowering interest rates, which will support the economy and lower borrowing costs for low-income households.
Additionally, management is making changes to improve the business. It's closing less efficient distribution facilities and shifting that business to permanent distribution centers. It's also investing in other improvements like having more employees at the front end of stores and improving in-stock levels so customers can find what they're looking for more easily.
Management expects the rest of the year to be challenging, but the business should eventually improve, and the stock looks like a bargain right now.
Even after slashing its guidance, the stock trades at a forward price-to-earnings (P/E) ratio of just 14, which is significantly lower than rival Walmart with its forward P/E of 33.
Walmart is clearly outperforming Dollar General and deserves to trade at a premium, but Dollar General looks oversold at this point. Even a modest improvement in its results should lead to a rebound in the stock price and a higher valuation.
With inflation down and interest rates falling, Dollar General could get relief faster than the market seems to think.
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Jeremy Bowman has positions in Target. The Motley Fool has positions in and recommends Target and Walmart. The Motley Fool has a disclosure policy.
