Dollar General and Dollar Tree Earnings Are the Next Big Test for Retailers

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Dollar General

and

Dollar Tree

report earnings next week, but the stocks got crushed well in advance of their releases. That’s because investors are pricing in bad news that’s almost certain to come—and may create a buying opportunity if the news isn’t as bad as people fear.

Dollar General (ticker: DG) fell 11%, its biggest percentage decrease since 2016. Dollar Tree (DLTR) tumbled 14%, its largest percentage decline since 2001, according to Dow Jones data.

Although Dollar General and Dollar Tree don’t report until next Thursday, the market is worried they won’t have good things to say. And after

Walmart

(WMT) and Target (TGT) reported earnings, those fears are justified.

On Tuesday, Walmart missed earnings expectations and lowered its guidance, causing the stock to sink. Although Target caters to a slightly more affluent crowd than Walmart, it too had a disappointing quarter, deepening concerns about retail.

The combination hurt retailers across the board, especially as Target and Walmart noted that shoppers were pulling back sharply in discretionary categories, and expected margin headwinds like higher transport and labor costs and supply chain disruptions to persist.

Walmart is the most analogous to the dollar stores, so it’s a worry that the company said inflation was causing even bigger disruptions for lower-income consumers just as we pass the one-year mark of the last stimulus checks. Walmart also said it had started being aggressive in rollbacks in discretionary categories like apparel in the first quarter. The fact that it’s flexing its pricing muscle isn’t great news for direct competitors that also cater to shoppers who are laser-focused on value.

In light of this, it’s no surprise then that investors are bracing for more bad news when the dollar stores report next week. That’s particularly true for Dollar Tree, given that it skews more toward discretionary purchases. Clearly, the lower-income consumer is feeling the pinch, and that could hurt retailers that serve them.

Yet there are a couple of potential silver linings. The first is how brutal earnings season has already been. If the dollar stores can offer a less-bad-than-feared quarter, or even some glimmer of hope about the rest of the year, that could limit the downside to their stocks.

The second is that investors have already been able to factor in a lot of things pressuring the companies, but may not be expecting much to mitigate them.

“Operating costs are rising due in part to higher gasoline but also to labor,” says Quo Vadis Capital President John Zolidis. “The question is whether these pressures can be offset by improved traffic as the customer becomes more value-seeking and stays closer to home …due to higher gas prices.”

Indeed, the big jump in gas prices is counterintuitively slightly less bad for dollar stores than they are for Walmart. Dollar stores tend to have a greater number of smaller format stores dotted around the country, especially in low-income and rural communities. Big box competitors aren’t typically in these areas, and for low-income consumers carefully watching every mile they drive amid high gas prices, a closer location means dollar stores are much more appealing than Walmart.

We may already be seeing some evidence of that. Jefferies analyst Corey Tarlowe notes that foot traffic was down around 1% year over year, on average, across the value and discount retailers he covers in April, but that was a “meaningful improvement” from March’s 7% decline. He thinks this is an “encouraging sign for the value retail space, and we believe that foot traffic trends are likely to improve through 2022, particularly if a consumer trade down becomes more pronounced.”

Walmart specifically said that consumers were trading down during its conference call, especially in categories like protein and dairy where prices have noticeably increased. Dollar General—which has built out its grocery offerings in recent years—saw double-digit year-over-year foot traffic growth in April, Tarlowe highlights, with Dollar Tree’s Family Dollar not far behind, with a 9% bump.

That view was seconded by Ethan Chernofsky, vice president of marketing at foot traffic analytics firm Placer.ai, at Placer.ai, who notes that dollar and discount store traffic was already up compared with prepandemic levels for much of 2021. But what’s especially noteworthy is that recent visits have accelerated on top of an already strong baseline, Chernofsky says. That “visit increase since the beginning of the year is much greater than for superstores,” he notes. “So, while inflation is also beginning to impact dollar store prices, foot traffic data indicates that dollar store prices are likely still low enough to attract shoppers looking to stretch their paycheck.”

Management performance could be another area where dollar stores could outperform. Given both Walmart and Target admitted missteps in their quarters, if dollar stores were able to position themselves better in the face of rapidly changing fundamentals, that could help them. Likewise, these companies aren’t immune to the rising transport costs and supply chain disruptions plaguing the industry, but if the impact of these is less than it was on big-box retailers, investors would welcome that news.

Ultimately, it’s easy to see why the market has soured so aggressively on the dollar stores: Walmart sounded the alarm about lower-income consumers’ spending ability, it sees ongoing profit headwinds that will likely be shared by other discounters, and it’s already discounting some categories of merchandise. Those factors are worrisome for companies that compete with it.

At least these companies now have a low bar to clear, but it remains to be seen whether or not it’s still high enough to trip them up.

Write to Teresa Rivas at [email protected]