Dollar General (NYSE: DG) stock has found itself on the "deep discount" shelf. So far in 2023, the S&P 500 is up over 10% following its September swoon, but the retailer's shares are down nearly 60% through early October.
The steep stock price drop might represent a tempting buying opportunity for investors seeking value. Alternatively, it might signal deeper losses on the way for Dollar General as consumer spending slows further. Let's look at why shares have fallen so hard in the past few months, and whether the drop is an overreaction to Dollar General's short-term issues.
Dollar General is seeing trouble on aisle 3
Stock price declines exceeding 50% in less than a year's time don't typically happen absent some worrying operating and financial issues. Dollar General is no exception to this rule. Comparable-store sales were flat this past quarter, missing management's short-term outlook. Rival Dollar Tree posted a 7% year-over-year increase for the comparable quarter. That suggests Dollar General might be suffering some market share losses as consumer spending habits shift.
The news was worse around profitability, which declined sharply into mid-2023. Dollar General blamed several issues for this slump, including a tilt in demand toward low-margin consumables like groceries. But the biggest headwind came from increased promotions.
Dollar General had to cut prices to convince shoppers to keep spending at its locations. Management said the moves helped traffic trends improve late in the quarter. Yet the retailer still handled fewer visits than in the year-ago period. And operating profit fell 24% to $692 million.
Dollar General has too much inventory
If Dollar General's approach to inventory is any indication, then its sales challenges are likely to get worse before they improve. Management is trying to quickly reduce its pace of inventory purchases, suggesting that customer traffic levels might stay depressed for a while.
Dollar General lowered its short-term outlook in late August and now sees comps staying flat rather than rising by between 1% and 2% as executives had previously forecast. Earnings are now on pace to drop by as much as 34% to $7.10 per share.
Some of that pressure will come from new spending on the business that should deliver positive returns, for example through increased wages and more store remodels. But the payoff from these projects likely won't start arriving until 2024 and beyond.
Watch this stock
Dollar General in August joined Dollar Tree in reducing its 2023 sales outlook after Q2 demand trends slowed. Beyond that broader market pressure, the value retailers are dealing with higher shoplifting rates, rising transportation costs, and a continued tilt toward consumer essentials like home cleaning supplies. There's a risk that a recession would further amplify many of these issues.
You might feel tempted by the stock price slump to establish a position in Dollar General today. Shares trade for 0.6 times annual sales, after all, down from 1.6 times sales at the start of 2023. Dollar Tree's valuation has come down as well but it still sits at 0.8 times revenue.
That discount makes sense considering the big questions around Dollar General's rebound plan. Management is enacting some bold moves aimed at righting the ship all while balancing the need for cost cuts with a desire to keep investing in the business. Yet it will likely be several quarters before it is clear that these moves are producing the desired returns.
In the meantime, profit margins will take a big hit. That's why investors might want to simply watch Dollar General stock until customer traffic returns to healthy levels and profitability begins marching back up toward 10% of sales.
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Demitri Kalogeropoulos 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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
