Don’t bet on the dollar’s general action despite 5.4% inflation

Inflation is rising while income is not. In low-income areas, more people shop at dollar stores, which mostly sell items for less than $ 10 (rather than $ 1 or less).

Does this surge in demand make inventory at the largest dollar store chain, Tennessee-based Dollar General – which is set to release its second quarter results on August 26 – a bargain?

I would stay away from Dollar General stock – which rose 18% in the year ending August 20 (while the S&P 500 rose 31%). After all, it faces competition in these low-income regions, which means its top-line growth could be disappointing unless it keeps raising prices to keep up with inflation.

(I have no financial interest in the securities mentioned in this article).

Inflation sends low-income consumers to dollar stores

Low-income people cannot afford the groceries they need. So they buy from dollar stores rather than local grocers – which you think only sell items for a dollar or less – but in fact sell most items for less than $ 10.

One example is Kyle Dishman, an Ohio-based Vans worker whose weekly hours during the pandemic have been reduced from 32 to 20. According to the Washington post, he can get his $ 40 budget to cover “a week’s groceries – pasta, frozen pizza and canned vegetables – and the occasional can of motor oil for his Chrysler 300” by shopping at Dollar General. While Dollar General is still cheaper for him than his local grocer, he told the Post that prices have risen so much that he is now rationing his food.

In response to growing demand, dollar stores are expected to open 1,650 stores this year, which is about half of all new national store openings, according to Coresight Research., which analyzes shopping habits using location data from 30 million devices, says foot traffic at Dollar General is up 32% from pre-pandemic levels – far more than Walmart’s 3% increase, the Post noted.

What is behind this booming demand? 5.4% inflation and high job losses among low-income workers.

Demand is driving new dollar stores in low-income areas

Among the more than 34,000 dollar stores in the United States – Dollar General (with 80% of items sold under $ 5) and Dollar Tree (which prices all of its inventory under $ 1) – are the leaders with a combined total of 94% of the total.

They’re concentrating their stores in low-income areas – with three- to five-dollar stores within a few blocks of each other. This tends to drive grocery stores – which have lower margins – to bankruptcy.

This translates into so-called food deserts where the nearest grocery store is over a mile away, Stacy Mitchell, co-director of the Institute for Local Self-Reliance, an advocacy group told the Post. non-profit rights.

It is bad for the health of low income people. While dollar stores sell packaged food, few sell fresh groceries – for example, only 7% of Dollar General stores provide fresh vegetables, fruit and meat, the report reported. Post.

Dollar General net sales decline as margins increase

Dollar General operates more than 17,000 stores in 46 states located within five miles of approximately 75% of the US population. In 2020, most (76%) of its net sales came from consumables such as paper and cleaning products, packaged and perishable foods, tobacco, and health and beauty items.

In the first quarter, Dollar General recorded a decline in net sales. As CEO Todd Vasos said, “Net sales fell 0.6% to $ 8.4 billion, due to a 4.6% drop in same-store sales,” according to Transcript of Dollar General’s First Quarter Results Conference Call.

Dollar General was satisfied with the results. As Vasos told investors, “Our first quarter results exceeded our expectations, reflecting a strong underlying performance across the company, which we believe has been improved by the latest round of payments. government stimulus “.

To support his optimism, he noted that the combined categories of non-consumables saw net sales growth of 16%. its gross margin rate increased 208 basis points and its diluted EPS increased at a “double-digit” rate.

What is behind this increase in gross margin? CFO John Garratt told investors that Dollar General’s 32.8% gross margin was due in part to higher prices and fewer employee thefts.

As Garratt said, the margin increase was due to “higher initial markups on inventory purchases, reduced markdowns as a percentage of sales, a greater proportion of sales from our non-product categories. consumables and shrinkage reduction as a percentage of sales ”.

It wasn’t all good news on the cost side. After all, he noted that the costs of transportation, store occupancy, winter storm disaster, labor, and depreciation have all increased.

Can the general dollar beat modest expectations?

Dollar General doesn’t expect much growth in 2021. But Vasos has given it a positive turn. As he said, “Despite the continuing uncertainty, we are increasing our annual sales and EPS guidance due to our strong outperformance in the first quarter.”

The midpoint of this forecast is to leave 2021 net sales unchanged. As Garratt said, “Net sales for the year will go from -1% to + 1%; same-store sales decline of 3% to 5% and EPS of between $ 9.50 and $ 10.20. “

Analysts expect Dollar General revenue and EPS to decline in the second quarter. According to NASDAQ

, second-quarter revenue is expected to fall 1.5% to $ 8.56 billion with EPS down 17% to $ 2.59.

Analysts have mixed outlook

Analyst Zain Akbari from The morning star

gives the company a valuation of $ 183, implying that Dollar General is overvalued by 28%. Akbari wrote that he “still expects mid-digit revenue growth and single-digit operating margins over the next decade.”

Simeon Gutman, Equity Analyst at Morgan Stanley

, is optimistic. He writes: “Dollar General (DG) is a premier trader offering a rare combination of 1) consistent, high quality top and bottom results; 2) visible store growth; and 3) a capital allocation policy favorable to shareholders.

He sees the buy share price since recent results “add more confidence” to his “10% long-term EPS growth algorithm, the rise of top-tier initiatives appears to be sustainable and we see an underestimated margin on the rise thanks to the deployment of the Fresh self-distribution. “Gutman wrote.

Still, I wonder if Dollar General will be able to keep raising prices if inflation remains high without losing sales to local competitors who keep prices lower.

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