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  1. Home
  2. / Investing

Dollar Store Companies Compete in a Challenging Environment

Each discount retailer took a hit on earnings Thursday, but was the market reaction appropriate?
By KEVIN CURRAN Aug 31, 2018 | 01:35 PM EDT
Stocks quotes in this article: WMT, DLTR, DG

Both the Chesapeake, Virginia-based Dollar Tree Stores, Inc. (DLTR) and the Goodlettsville, Tennessee-based Dollar General Corp.  (DG) showed they were not discounted enough for the market on earnings Thursday.

Both earnings releases for the companies were certainly mixed. While Dollar General showed promising growth year-over-year as net sales increased 10.6%, it missed analysts' estimates on both earnings per share and revenue, by four cents and $90 million respectively. As a result, shares fell about 1% in Thursday trading, although they are up over 1% early Friday afternoon.

However, the slight share price cut for the discount retailer was nothing in comparison to its cost-saving compatriot Dollar Tree, which saw a precipitous 15.5% decline in share price yesterday after it lowered its guidance. Dollar Tree shares are up less than 1% Friday afternoon.

Along with pressure from flat sales growth at Family Dollar, a struggling contemporary which the company acquired in 2015, and a squeeze on its already small margins, the company looked overpriced for the market.

Macro Issues

Paradoxically, one problem for each retailer is the strength of the American economy.

As the economy continues to boom and the American consumer keeps a fatter wallet, discount retailers like Dollar Tree and Dollar General are left behind for higher-cost and higher experience retailers.

"With the environment already robust in terms of consumer spending, macro offers little help until a recession like a trade down event occur," surmised Deutsche Bank analyst Paul Trussell.

J.P. Morgan also noted that record low unemployment and a reduction in food stamps usage in recent years pressures the typical customer base for each retailer.

Additionally, each retailer is taking significant hits to their already small margins as tariffs impact their ability to import low-cost Chinese goods to achieve their trademark price points.

"The company, along with other retailers, recently learned of an anti-dumping duty assessed by the U.S. Department of Commerce on certain Chinese driven products," Dollar Tree CFO Kevin Wampler explained.

As a result, he said the company is due to incur a four cent loss on its earnings per share in the third quarter, as U.S. government action on Chinese goods thins their purchasing ability on the cheapest products.

Paradigm Shift

Another issue for each company is the movement of retail to the online marketplace

A common thread through the recovery in retail earnings reported over the past quarter was an increase in e-commerce revenue.

Larger discount compatriots like Walmart (WMT) , for example, showed marked increases in sales which derived in large part from store pickup, online, and delivery services.

None of these options are available at the margin conscious dollar store competitors.

Too Discounted to Ignore?

To be sure, analysts are not confident that the market is punishing the stores appropriately for their shortcomings and, per Factset data, 9 out of 14 analysts covering the earnings of Dollar General are rating the stock a buy, while no analyst has advised selling the stock.

Meanwhile, over half of analysts surveyed by Factset are advising buying Dollar Tree despite the disastrous Thursday impact on its share price.

Also, should the U.S. economy incur any trouble, analysts are confident that a sales pickup would be imminent based on an "improved" macro environment.

"We see a favorable skew of macro outcomes, with DG likely benefitting in a recession scenario, while also likely to grow and gain share should a low-growth consumer environment continue," Morgan Stanley equity analyst Vincent Sinisi wrote in a note yesterday.

"Utility bills have been higher this summer, because of all the heat across the country and rents; if you take a look at any trend that I do, it still shows rents continue to go up three years going now," DollarTree CEO Gary Philbin told analysts yesterday.

So, even aside from the doomsday scenario of a recession, each retailer might have room to profit from struggling shoppers, offering investors an opportunity-so long as they know the risks.

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TAGS: Investing

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