The Latest From Dollar General, Petco, and Five Below

Dollar General (DG 0.19%) and Five Below (FIVE 0.32%) are in the same category, and both came out with fourth-quarter reports that highlight (among other things) their opportunities for growth. In this episode of MarketFoolery, Motley Fool analyst Emily Flippen joins host Chris Hill to analyze those stories as well as Petco's (WOOF 0.31%) first earnings report as a public company.

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This video was recorded on March 18, 2021.

Chris Hill: It's Thursday, March 18th, welcome to MarketFoolery. I'm Chris Hill. With me today, the one and only, Emily Flippen. Thanks for being here.

Emily Flippen: Thanks for having me, Chris.

Hill: We've got discount retail, we've got pet retail. We're going to start with Dollar General. Their fourth quarter was all over the map, sales looked good, profits were lower than expected. The same store sales picture for the quarter seemed like it was pretty good, but shares of Dollar General are down 6%, 7% this morning. Start wherever you want, when you look at Dollar General this morning, what do you see, what stands out to you?

Flippen: Let's start with the good. Dollar General has been a really consistent and economically profitable business for a very long time, and this quarter was no different. They beat in terms of revenue and comparable store sale expectations. Revenue was up nearly 18%, with same store sales up nearly 13%, but that was also accompanied by this increase in operating profit as well. Fundamentally speaking, good quarter for Dollar General, which I'm sure has a lot of investors scratching their heads thinking, "Okay, well, what am I missing here?" I think the aspect that was missing was actually guidance. Dollar General did something really weird this quarter, that we don't see a lot of retailers doing. They provided full year fiscal '21 guidance, and their revenue guidance was less than stellar, let's say, a guidance of -2%, 0% revenue for the next year. Same store sales decline of 4%, 6% for the next year. All of those because they're coming off of what is a really tough comparable base in 2020. Despite Dollar General trying to highlight how excellent it is in comparison to 2019, I think investors are caught up in that guidance.

Hill: I've been thinking for a while that we're coming into a period where, in a given industry, some companies are going to provide guidance, others are not, and the ones that don't might get "punished" in air quotes. They might get punished by Wall Street analysts for that, and therefore their stocks could sell off. Thank you for reminding me that analysts are not going to give extra credit to [laughs] companies that provide guidance, they're just going to look at the guidance and act accordingly. In the case of Dollar General, they're not getting bonus points for providing full year guidance for 2021, instead, people are looking at it and saying, "Yeah, this is not what we're looking for." This is a business that has done pretty well over the past year. The stock has done pretty well, but this is not one of those situations where the stock has doubled in the past 12 months. Therefore, on valuation concerns, it's selling off today.

Flippen: That's exactly right, and I think the sell-off that we're seeing today is associated with the short-termism that we sometimes see on Wall Street, getting caught up in what's going to happen over the short to intermediate term without looking at the bigger picture. Even with guidance, if you do look at the bigger picture, in comparison to 2019, their same store sales would actually be increasing 10%-12% on a two-year basis. It's not like this is a declining business, it's not like this is a business that is losing margin. In fact, their gross profit actually increased. The miss on the bottomline was mostly associated with paying appreciation bonuses to their employees and these COVID costs. These things are short term. If you're an investor in Dollar General, I would look at this quarter and think to myself, "Outstanding quarter." I think it sets up well over the next year plus, don't get caught up in the short-term comparable store sales on a base of what is an extremely unusual pandemic driven year.

Hill: Petco issued its first earnings report as a public company. On the surface, things looked good with profits and revenue higher than expected. Same store sales up 17%, but shares of Petco are down a little bit this morning, which has kind of been the trend line for the stock since it went public in January.

Flippen: Petco is in a weird position where they're trying to pitch themselves as a completely reformed, all inclusive pet care company, when I think investors and mostly customers, still see them as a legacy retail player in the pet space. It's certainly a competitive industry, but Petco had a decent quarter. They had revenue growth of 16%, comp growth of nearly 17%. Both of those were above the guidance expectations they had provided when they went public. It was not by any means a bad quarter. I think the focus is just going to be on can this business truly turn itself around to take on the likes of their competitors? Chewy comes to mind as a big one, and its relationship with PetSmart. They're going to have to drive a lot of people to their e-commerce businesses, and we saw them doing that in this quarter. Although, we also saw them taking big discounts for customers that chose to go retail. They were running promotions like 25% off orders over $50 if you buy online and pick up in store. That sort of incentive allows them to increase their active customers, which is great, but they need to retain those customers and not lose them back to other e-tailers. It was a good quarter, but I think long term, the question mark is still out about the business.

Hill: I'm absolutely one of those people who thinks of Petco as a legacy retailer. There is a version of this that works out for them that if they are able to get people in the stores, maybe you get more of those impulse buys, that sort of thing, and boost that average ticket. I think it's worth noting that this is a company that's been around for a long time. The market cap is around $5 billion, which means it is one sixth the size of Chewy. [laughs] Did management talk at all about what they're attempting to do on the digital side of things? Because yes, obviously, they want to make the best use of the space that they have, the physical space that they have. There's a reason they want to get those people in the stores. They can't just cede the ground to a business like Chewy.

Flippen: Management has taken on that conversation and answered it. I think they take it on that question head on. In the most recent quarter, an analyst actually asked them directly, they said, "You have a really large e-commerce competitor. How are you going to win against them?" Management said, "Same-day delivery." They're using their store locations as these micro hubs for delivery and actually partnering with DoorDash to save on the shipping costs. They can actually have same-day delivery, an option that we don't see with online e-tailers like Chewy. In fact, 30% of their online orders went through same-day delivery. It's an interesting business model. Management likes it, because they say regardless of whether or not somebody is getting a bag of heavy pet food or just a simple dog toy delivered, their delivery costs by using DoorDash are actually the same versus something like Chewy which is trying to ship really big, heavy stuff, they have to charge delivery fees if your order's below a certain amount. It'll be interesting to see if this strategy wins. Unfortunately, because of their partnerships and using third parties, their margins on these sales are much lower, and while they are profitable, part of the reason why this business is only trading at one time forward sales is because so little of that flows to the bottomline.

Hill: Two quick things before we get to our final story. First, quick shout out to long time listener Sam Murphey. Happy birthday, Sam, celebrate safely and of course, the safest way for an investor to celebrate these days is to just stay in the comfort of your own home and buy a stock off your watchlist. I get that that's not as fun as partying with your friends, but look on the bright side. If you do it right, 10 years from now, the stock you buy today, that could fund a really great party with your friends. Think of it that way. For anyone looking for stock ideas for your watchlist, check out our flagship service Stock Advisor. You get stock recommendations from Tom and David Gardner. You get their Best Buys Now and a lot more. You can get a 50% discount for being one of the dozens of listeners. Just go to stockideas.fool.com. We've got a link that you can just click in the description of this episode. 

Five Below wrapped up the fiscal year with a bang. Fourth quarter profits and revenue came in higher than expected. Same store sales were up to 14%, the stock is down a little bit this morning. Is that driven by guidance?

Flippen: It is in part driven by guidance, as we talked about. Whether or not retailers give guidance is this big question mark and Five Below is maybe getting punished because they didn't provide full-year guidance expectations heading into 2021. But they did provide a guidance framework [laughs] which is, I guess you can say management's workarounds, and that framework included --

Hill: Wait, I'm sorry to interrupt you. Did they actually use that phrase, "guidance framework?"

Flippen: Yes. That is a direct quote, "guidance framework," from their call, and that guidance framework maybe framed up a picture that was a little bit less than expectations, although admittedly, long term investors could have predicted this. This is a more normalization of growth and margins and encouragement for investors to compare 2021 performance against 2019 instead of 2020, and a difficult year in terms of comparable store sales growth. So a lot of those same challenges that we saw happen with Dollar General in this most recent quarter, Five Below seems to imply that they may be facing those especially in the second half of the year. But moving apart from that short-termism, if you look at just this quarter's performance, things were really great for Five Below. Anecdotally speaking, Five Below always has a line outside of it, at least in the areas where I'm located, and that definitely showed up in this quarter. They beat estimates and revenue. Revenue grew nearly 25%, pretty stellar for this retailer, and they're investing a lot into opening new stores and improving the digital experience.

Hill: I want to get to that in a second, but to be fair to management, this is a stock that's up 250% in the past year, so I think if I'm a shareholder, my thinking is they can use whatever language they want to describe how they're going to give guidance. If the stock is going to do that type of performance in a single year. They've got 1,000 locations, I'm curious what you think about where they should be going because certainly, they can expand their footprint. They have a fraction -- and I know they're not exactly in the same business as Dollar General, they're in the same category, and they have a fraction of the number of locations. They're not in all 50 states, I think they're in 38, maybe 40 states so they can expand their physical footprint. They can obviously invest in digital. Where do you think they should be going?

Flippen: Well, one big aspect for them is going to be increasing their footprint,as you mentioned. They have just over 1,000 stores, but plan to open up to 2,500 stores and even amid the craziness that was 2020, they opened up 120 new stores. So growth, that 25% topline growth we saw this quarter. In order to sustain those double digit numbers, they need to expand store counts. They're not nearly as saturated as what management believes they can be. But I do think it moves beyond just expanding their stores and into the branding of Five Below: self checkouts, investments in digitization, moving things to get people to walk to the back of the store, as opposed to just venturing 10 feet in and then leaving, which is an issue that they've had in the past. All of those can do things to increase their average ticket volume, which is going to do great things. Maybe not as an investor, but as a consumer, I think the best thing Five Below could do, and maybe they're keeping this in their back pocket to pull out at some point in the future, is change their name, because every person I know who has never walked into a Five Below, thinks Five Below is a store that sells winter coats or ski gear or something, and how they've managed to have this level of success in, what is in my opinion, very poor levels of branding is beyond me.

Hill: Do you have a name in mind? I mean, we can obviously solicit ideas from the dozens of listeners, email us at [email protected]. I will confess, I'm one of those people. The first time I heard about this business, knowing nothing about the business, that's what I thought. I thought, "Oh, are they a competitor to REI and they sell winter gear, that sort of thing?" It's like, "No, it's a discount retailer." Okay, well, the name doesn't necessarily suggest that as much as you might think.

Flippen: I think what they need to do is they need to pay Dollar Tree or Dollar General some consulting fees to have them come in and think about a name that can imply that they have this low cost, the $5 price point, $10 price point. Well, also not making me think that I'm going to spend $500 on a winter jacket. I don't feel like that should be too hard, but they struggle with it. 

Hill: Emily Flippen, always great talking to you. Thanks for being here.

Flippen: Thanks for having me.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. See you on Monday!