Dollar General Earnings: Problems Reflect Pressured Core Clientele, Not Fundamental Weakness
Equity Analyst Sean Dunlop
Sean Dunlop
Equity Analyst
Analyst Note | Sean Dunlop | Aug 31, 2023
For the second straight quarter, narrow-moat Dollar General posted lackluster earnings, cut its guidance, and was punished by the market for its shortcomings. The firm's core customer remains under pressure, acutely sensitive to sticky inflation in nondiscretionary expenses, and pulled back on purchases in the more cyclical seasonal (negative 1%), home goods (negative 7.7%), and apparel (7%) categories in response. While we expect to lower our own $191 intrinsic valuation by a mid-single-digit percentage'consistent with higher-than-expected shrink, a 2.25% reduction in full-year revenue guidance at the midpoint (to 1.3% to 3.3% from 3.5% to 5%), and a material downgrade in expected profitability'we continue to view issues as ephemeral rather than structural and see significant long-term opportunity in the name.

More concretely, we expect to bring our prior full-year sales ($39.2 billion) and earnings ($10.06) estimates into the revised range ($38.6 billion and $7.70 in EPS at the midpoints) and now expect a margin recovery to bleed through 2024. Comparable sales have been a particular drag, falling 0.1% during the quarter (far worse than Dollar Tree and Family Dollar's positive 7.8% and 5.8% results) as traffic remained anemic. The direction of pressure is unsurprising, with consumers favoring lower-margin consumables (up 6%), but the magnitude surprised both ourselves and management, driving the market's reaction.

More positively, we don't view current pressure as an appropriate bellwether for Dollar General's long-term prospects. The firm's core customers, who live in rural areas and make less than $40,000 per year, are feeling a disproportionate share of current macroeconomic pressure and some pullback in demand should have been expected. With labor and rental costs set at least in part by the broader market, it's no surprise to see sharp operating deleverage in hindsight, and we expect a full recovery to high-single-digit margins as macro pressure abates.