Dollar General's (DG -0.41%) share price has fallen by more than 54% this year, compared to the S&P 500's 12% gain. That's certainly painful for investors.
But it's important to look to analyze the company's future prospects. Has the market overreacted, or is it a signal to stay away from the shares?
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Sales momentum halted
Dollar General sells most of its items for less than $10. In a high inflationary period, customers should flock to its stores. But that hasn't been the case.
Showing remarkable resiliency through the years, Dollar General posted positive same-store sales (comps) from 1990 through 2020. Following the pandemic, the company posted a positive comp in 2022.
However, its fiscal second-quarter comps fell by 0.1% for the period that ended on Aug. 4. The company realized higher average retail prices, but management stated there was lower customer traffic and fewer items per transaction.
Meanwhile, competitor Dollar Tree's namesake chain and Family Dollar stores had strong sales gains. Fiscal Q2 comps rose by 7.8% and 5.8% at Dollar Tree and Family Dollar stores, respectively. This was driven by higher traffic, and management noted market share gains. The period ended on July 29.
Weaker margin
Dollar General's consumables category makes up the biggest portion of sales, about 80%. These consist of basic items like paper towels, disinfectants, food, and shampoo. These low-margin items are designed to generate store traffic and higher-margin purchases. That didn't happen, though.
In Q2, Dollar General's gross margin contracted by 1.3 percentage points to 31.1%. Management partly blamed higher sales in the lower-margin consumables category while sales fell in the other areas. It also cited higher theft, inventory damages, and markdowns.
The combination of lower sales and decreased margin has led to lower profitability. Dollar General's quarterly diluted earnings per share (EPS) fell by 28.5% to $2.13.
It also lowered its sales and profitability expectations for this year. Management expects this year's comps to range from a 1% decline to a 1% increase. Previously, it anticipated a 1% to 2% increase. It now anticipates diluted EPS to fall by 22% to 34%.
Reviewing Dollar General
It's a good idea to regularly review your holdings. Otherwise, you would have been lulled into complacency by Dollar General's previous performance.
With the stock's drop this year, the valuation has become cheaper. The price-to-earnings (P/E) ratio fell to 10 from about 25 at the start of the year. That's much lower than the S&P 500's P/E of 25.
It's important to remember Warren Buffett's saying: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." Dollar General's prospects appear murky right now. It was already seeing lower customer traffic, and now interest rates seem likely to stay elevated, which would hurt Dollar General's core customer.
Hence, despite the low P/E multiple, I would sell Dollar General shares.
