Just last week Dollar Tree came out of nowhere to trounce third-quarter earnings estimates and slightly raise its full-year profit outlook. And on the earnings call, executives were, refreshingly, not all doom and gloom about the plight of the low-income shopper in the wake of food stamp cuts this year. In fact, the tone of the call was a touch better than the second quarter, when the company's weak results really caught everyone by surprise. Following the market's embrace of Dollar Tree's third quarter, shares of Dollar General rose about 4.3% ahead of its results on Thursday.
Unfortunately, what Dollar General had to say -- as well as the nasty response to it by the market -- on its earnings call reinforces that I was probably too early in thinking an inflection point has formed in dollar store stocks. Because for an inflection point to occur, meaning the stocks subsequently climb higher, there has to be signs that negative trends in the business, such as tepid traffic, are starting to turn the corner. I didn't come away with that impression from Dollar General, and am now concerned Dollar Tree's upbeat earnings call was all smoke and mirrors.
Top Concerns Right Now on Dollar Store Stocks
- Food stamp cuts across the country have low income shoppers sidestepping higher margin discretionary departments. Departments such as home goods have to do OK for dollar stores to produce strong earnings, as their margins on food items are razor thin.
- Food stamp cuts may be affecting how much food people are buying. I don't think dollar store shoppers are going hungry each day, but the cuts in benefits probably mean a few less items in their refrigerators and a focus on getting the most from what they have in the cupboards.
- Dollar stores are now fully engaged in a price war started by Walmart (WMT) earlier this year. That is not a good place to be in when your business model is to sell stuff mostly at a $1. More price cuts and promotions lay ahead for Dollar General in 2017, while Dollar Tree will likely continue to offer more products priced at a $1.
- Food deflation has persisted longer than most expected, which is continuing to create downside risk to Wall Street sales estimates.
- Wall Street remains overly bullish in their estimates for the dollar stores. They are being blinded by the hearty new-store opening plans by the group.
- Neither company is not showing a willingness to slow down their aggressive store opening plans to save money, and re-evaluate the business in light of weaker sales. That's bothersome.
- Winning retailers right now are ones with a strong mobile-ordering presence. The market will reward names such as Growth Seeker holding Amazon (AMZN) and Walmart as a result. The dollar stores, due to their business models, are just not anywhere near where they need to be when it comes to the shopping environment of the future.