3 Reasons to Stay Away From Dollar General

Dollar General no longer performs like it did last year, so now is the right time to book profits.

Apr 2, 2014 at 4:37PM

Discount retailer Dollar General (NYSE:DG) has been dogged by severe weather conditions and weak consumer confidence among low-income shoppers in 2014. Moreover, the news that CEO Rick Dreiling recently offloaded 323,197 shares of the discount retailer for $18.7 million hasn't helped investors' confidence either. In addition, competition in the discount retail space is rising with big-box retailers Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) focusing on smaller-format neighborhood stores.

Also, Dollar General's outlook for the current year doesn't come up to the mark. The company expects earnings in the range of $3.45-$3.55 per share, while analysts expected $3.69. With the stock down almost 9% this year and the outlook downright gloomy, things look grim for Dollar General after a solid 2013. As such, investors should consider exiting the stock as its growth has slowed down remarkably and certain other factors could hurt its business further.

Wal-Mart's threat
First off, Dollar General will struggle due to cuts in government assistance plans that will hurt its low-income customers. This is nothing new, as several big-box players such as Wal-Mart and Target also face such issues.

Next, Dollar General is also feeling the heat of tough competition. Aggressive promotional activity hurt its sales in the holiday quarter, and the trend could continue going forward as the discount retail space gets more crowded.

Wal-Mart, for instance, is pushing its Neighborhood and Express stores. These stores aren't as big as a typical Wal-Mart supercenter but they performed better than the large stores last year. Sales at these smaller stores were up 4% for the last fiscal year. Encouraged by this performance, Wal-Mart plans to open 300 new Express and Neighborhood Market stores this year, twice as many as it had planned earlier. 

In addition, Wal-Mart has also introduced an online tool that will allow customers to compare prices of 80,000 food and household products against those of its competitors. Such a move by Wal-Mart could intensify price competition and lead to more competitive pricing by competitors.  

Target joins the bandwagon
Even Target plans to introduce smaller-format TargetExpress stores. In January, Target completed a lease for a 20,000-square-foot location in Minneapolis to test this format. These stores will still be double the size of an average Dollar General store, but they will be one-fifth the size of a regular Target location. Target's move indicates that it is trying to enter urban areas, which will further crowd a space where profit margins are narrowing and competition is growing.

Target has been under a lot of pressure lately due to a massive data breach and a poor expansion strategy in Canada. Its profit was down 46% year over year in the previous quarter, and the company is testing new ways of getting back on track. Experimenting with a smaller store format is an ideal strategy since peer Wal-Mart has already seen some success with this move.

Not a bright picture
According to Dreiling, "[Dollar General's] core customer doesn't feel that she is out of the woods yet, economically, and continues to be cautious with her spending." Hence, management does not have confidence in consumer spending patterns and the bad fiscal-year outlook evidences this.

Dollar General underperformed massively in the previous quarter, with same-store sales growing just 1.3% while analysts were looking for 4.5% growth. Given the uncertainty around consumer spending, its same-store sales could decline further in the future.

The bottom line
Dollar General was the pick among the dollar stores during the last fiscal year, but sadly it doesn't look like a convincing investment anymore. Its vital metrics are on the decline and greater competition in the industry could hurt its performance going forward.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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