There's no denying that Dollar General(NYSE: DG) shareholders were sucker-punched last week. In response to the discount retailer's second-quarter earnings miss and lowered revenue guidance for the remainder of the year, shares fell 32% on Aug. 29, the stock's worst day ever.
Most investors are now more than a little leery of owning a stake in the discount store chain. But if you believe it's darkest before dawn, with the stock now down 68% from its 2022 peak and trading at a seven-year low, this might actually be a prime time to buy shares in this savvily positioned company.
"Financially strapped"
Dollar General dished out some serious disappointment with its second-quarter numbers. Although overall sales grew 4.2% year over year to $10.21 billion, growth in same-store sales (comps) was an anemic 0.5%. Operating profits actually fell 20%, dragging per-share profits down from $2.13 a year earlier to $1.70 this time around. Analysts were looking for earnings of $1.79 per share on a top line of $10.37 billion.
Fanning the bearish flames was lowered sales guidance for all of 2024. The retailer had been modeling revenue growth of between 6% and 6.7%, fueled by more cost-conscious consumer spending. Now it's only looking for revenue growth between 4.7% and 5.3%, with comps growth dialed back to an expected range of only 1% to 1.6%.
Perhaps the brunt of the post-earnings plunge, however, was driven by the fact that these numbers contrasted so starkly with those from similar Walmart. It produced top-line growth of 4.8%, fueled by same-store sales growth of 4.2% within the U.S. The retailer also raised its full-year revenue and earnings guidance.
What gives? The key is the difference between the two companies' typical customer. As CEO Todd Vasos commented during the second-quarter earnings conference call, the "lower-end consumer continues to be very much financially strapped, especially as it relates to her ability to feed her families and support her families."
With Dollar General's core value-minded customers unable to continue spending as they have in the past, the retailer is largely on the defensive until things get better. That could take a while, though, and matters could remain miserable for the company in the meantime. Given this, it's not surprising investors panicked.
Just remember one important idea about how the economy and the stock market work.
Dollar General's worst-case scenario is its current reality
Dollar General doesn't really go head-to-head with bigger players like Walmart or Target. If anything, it mostly avoids competing directly with either chain. Whereas Target and Walmart stores are typically found in heavily populated areas, 80% of Dollar General's stores are in often-underserved small towns with populations of less than 20,000.
It also caters to the households with lower incomes more likely to be seen in such locales, according to data from market researcher Numerator. Products with customized product sizing allow for lower prices, for example. Much of its inventory is also private-label stuff, giving the retailer even more control over how it meets the needs of its most frequent shoppers.
And the strategy usually works great. The discount retailer saw incredible revenue and footprint growth between the end of 2008's subprime mortgage crisis and the beginning of the pandemic.
The circumstances since 2021, however, have been extraordinary. Namely, inflation has been rampant. The U.S. Consumer Price Index is now 21% higher than four years ago, and that number arguably understates the actual effective increase in the cost of living. Income growth just hasn't kept up. That's why for the better part of the past three years Walmart has been touting that most of its gains in market share have come from households earning in excess of $100,000 per year -- this crowd's looking to stretch their dollars too. McDonald's recently reported disappointing quarterly results largely as well because, according to CEO Chris Kempczinski, customers "continue to feel the pinch of the economy and a higher cost of living." And that echoes recent observations from executives with PepsiCo and other consumer-facing companies.
It's a problematic dynamic for Dollar General simply because its core customers -- lower-income rural households hit hardest by inflation -- aren't changing how they're shopping or what they're buying. These consumers are simply spending less. Underscoring this idea is similar results from direct competitor Dollar Tree. Its Dollar Tree brand saw modest same-store sales growth of 1.3% last quarter, while its Family Dollar banner actually suffered a same-store sales decline of 0.1%.
In light of all of this, it's not surprising that investors are worried about the retailer's foreseeable future. But there's something the market seems to be forgetting here.
The risk is worth the reward for strong-stomached investors
That is, the economy is reliably cyclical, but ultimately growing. The past couple of years have been the extreme exception to this norm, creating the affordability crunch that's crimping consumer spending now.
There's never been any doubt about Dollar General's business strategy, however. The economy that usually works in Dollar General's favor will do so again sooner or later, and likely sooner than later.
And waiting for clear evidence of that rebound to dive into Dollar General stock could be a strategic mistake. Stocks have a funny way of trading predictively, reflecting probable results anywhere from a few months to a couple of years into the future.
So while it's struggling right now, Dollar General is likely to be faring better soon. Its stock should start pricing in such a turnaround even sooner. Indeed, now down 68% and trading at a seven-year low, the worst-case scenario may already be priced into the stock, and then some.
Taking a swing right now isn't for the faint of heart. The likely volatility could prove unsettling even if its net effect is bullish. Keep it in perspective if you're inclined to dive in.
If your gut is telling you to dive in, though, don't be afraid. As Warren Buffett likes to say, be fearful when others are greedy and greedy when others are fearful. And the market is clearly quite fearful of Dollar General right now.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target and Walmart. The Motley Fool has a disclosure policy.
