What happened

The stock market is up in afternoon trading Thursday, but one segment in particular, retail, is still getting beat up.

As I predicted last week, teen clothier Abercrombie & Fitch (ANF -3.98%) is one of the victims today with a 6.1% loss as of 12:25 p.m. ET -- but it's not the only retailer going down. The dollar store segment in particular is taking it on the chin today, with shares of Dollar Tree (DLTR -3.88%) shedding 10.2%, and Dollar General (DG -4.27%) down 1.3%, despite both stocks beating earnings estimates.

So what

A 1%-ish decline is actually good news for Dollar General investors -- the stock was down closer to 5% earlier in the day -- but it's still a bit of a disappointment. Reporting earnings this morning, Dollar General beat expectations with a $2.98 per share profit where Wall Street had only expected $2.93.  

Dollar General grew its revenue 9% year over year in the second quarter of 2022, meeting analyst projections, and its profits were up 11%. Operating profit margins were slightly weaker in this year's Q2 than in last year's, but Dollar General's policy of buying back stock resulted in fewer shares outstanding -- concentrating profits among those fewer shares and improving profit per share.  

The news at Dollar Tree was both better and worse. Worse, because sales grew only 7%; better, because earnings per share shot up 30% year over year to $1.60, beating analyst expectations for $1.59. In contrast to Dollar General (which is seeing a much smaller sell-off), Dollar Tree improved its operating profit margin by 120 basis points. Still, at 7.5%, Dollar Tree still lags Dollar General in profit.

And finally, Abercrombie: Instead of Wall Street's expected $0.22-per-share profit, Abercrombie & Fitch reported a surprise $0.33-per-share loss, and on much weaker-than-expected sales ($805 million). Sales sank 7% year over year at A&F, with gross profit margin plunging 730 basis points and operating costs as a percentage of revenue leaping 590 basis points higher.  

Now what

As I warned last week, exploding inventories -- and the need to discount them to clear stale styles -- were big factors in Abercrombie's Q2 disappointment. Although management is hoping that inventory growth peaked in Q2, inventories are still up 70% year over year, so the problem of clearing stale inventory, and probably accepting reduced profit margins to do so, remains. And as Abercrombie works through this problem, it's lowering guidance through the end of this year, predicting sales will not grow, but rather fall by mid single digits.

As operating profit margin erodes into the 1%-to-3% range, it's possible Abercrombie could be looking at a loss for this whole year.  

Likewise with the dollar stores. Inventories surged 25% at Dollar General in Q2, and were up nearly twice that amount -- 48% -- at Dollar Tree.    

Now, the good news is that unlike Abercrombie, both of the big dollar-store chains expect to see continued sales growth this year -- perhaps because their highly consumable wares don't really "go out of fashion" and become less desirable over time, in the same way that clothing does. Dollar Tree is looking for sales growth to continue in the 6%-to-7% range through the end of this year, and Dollar General actually thinks its sales growth could accelerate toward 11%.

On the profits front, Dollar General also sees earnings growth continuing to outpace sales growth -- up 12% to 14% this year. Dollar Tree, which is still working to catch up to Dollar General in terms of profit margins, will be making up for lost time with a 25% bump in earnings per share. If it's able to make that turnaround happen, then Dollar Tree at a 25% growth rate and 23 P/E ratio could actually be the better bargain than Dollar General at 14% and 25 times earnings.

As for Abercrombie & Fitch, though, I'm still of the opinion that so long as Walmart and Target are dumping inventories and sacrificing profit margins, it's probably best to avoid Abercrombie stock, no matter how "cheap" its shares may appear.