No. of Recommendations: 15
Despite the market action during and following the earnings call (it was up at $139 after earnings but has been dropping from there), I'm relatively positive going forward. A few small notes:
- I don't have a report in front of me, but last I saw DG was second in US retail sales when sales are organized by SKU. (The frontrunner by a very large margin is Costco -- good company to keep.) To a very significant extent, I think DG's moat stems from its ability to be a low or the lowest cost operator in its specialized niche, and it does this by combining scale with cost-efficient simplicity. Note, for instance, that its closest competitor, FDO, hit negative EBIT margins this quarter running a relatively similar business to DG.
Vasos' "back to basics" theme, coupled with his promise of material SKU reduction and optimization, strikes me as the right note to sound going forward. SKU reduction improves bargaining power for the retained SKUs and reduces cost and complexity in the supply chain. The markdowns of existing SKUs, including the clearance of a non-consumable glut, are a short term pain. The shifting mix to consumables will likely be more of a long-term headwind on margins, but I doubt that can be avoided. I'm hopeful we'll start to see positive results in the back half of 2024 as all this gets sorted.
- The emphasis on increased front end staffing strikes me as another necessary adjustment (due in part to the shrink & inventory/customer service issues), even if it means increased labour costs for the near future. One remark that struck me in the call was Vasos' note that they would be "reducing the span of control for our district managers which will provide more opportunity for engagement with our store managers and their teams and more consistency and execution across the store base."
I had a posted an insight Deutsche Bank note on the BRK board a while back, and this and other comments all suggest that Vasos is cleaning up some fixable problems that have cropped up over the last year or two. See
https://www.shrewdm.com/MB?pid=571789629 for the DB note.
The former DG VP specifically mentioned that "top-line growth is possible with improved in-stock levels and customer service", advised a 760 store growth rate (notably, Vasos brought it down to 800, or ~4%, from the historical target of 1000, or ~5%, but is still positive on long term growth) but was optimistic about the runway for future store growth, and broadly described the challenges that arose at DG thus:
Our expert, who left DG in early 2023 after six years with the company, sees the current challenges stemming from changes in the scope of responsibilities for field management starting in February of 2022. District managers saw increasing breadth of coverage and job complexity (more initiatives to implement including DG Fresh, NCI, BOPIS), with store responsibility increasing from 15-17 stores up to 25- 27 stores without a corresponding increase in resources. In addition, a heightened (and strict) focus on improving store standards without providing additional resources damaged employee morale and led to higher levels of turnover. This left the company without critical institutional knowledge, specifically in key store management and field leadership roles. As a result, prioritization of important, urgent, and critical tasks fell short.I went back and read the full note and it sounds very much like a tell-all about what was plaguing DG, and why Vasos was sounding the notes he was in the earnings call. I think the good news here is that these are fixable problems, and if the model isn't broken, there is still quite a bit of potential upside from here.
To some extent, I think the market is still pricing DG on the view that it is broken, and won't match its industry peers going forward. DLTR, DOL.TO, OLLI, and FIVE currently trade at rather lofty P/E rations, for instance (mid-twenties up to almost 40 for FIVE). DG's at about 17 times 2023 earnings. In a vacuum that isn't too cheap, but compared to industry peers, and taking into consideration that we're likely at or near a bottom on various matters (e.g., debt service costs; hits to the bottom line to clear out non-consumables; margin competition from FDO, i.e., FDO's cost cutting to draw traffic has hit negative margins, and its parent DLTR has begun a comprehensive review that is likely to lead to store closures and a rethink on margins; comps in 2024 will be to a weak 2023, as opposed to a strong 53-week 2022; etc), and there is a very credible path forward for future growth, I think DG's current multiple builds in the possibility of a strong climb once the horizon gets sunnier.
In brief, I'm guessing we see some choppy waters as this plays out but we'll start to see the old DG start to return around the back half of 2024.
