Dollar General (DG -0.41%) stock has had a brutal 2023, its worst year since the discount retailer went public in 2009. After posting strong growth and margins throughout the pandemic, the company now faces some major headwinds, and it has posted some of its worst financial numbers in decades. It is also struggling relative to its direct competitors, which has investors fearing that it's losing market share.
The stock trades down 55% from all-time highs, by far its worst decline ever. But in recent days, the stock rebounded by more than 10% after the company announced the return of former CEO Todd Vasos to the top job. But that doesn't mean all is well with Dollar General.
Poor results, new CEO ousted
Dollar General is the largest rural discount retailer in the United States. With the majority of its locations in small towns across the country, the business thrived by being a convenient location for shoppers on tight budgets to pick up cheap goods. It increased its footprint significantly in the past 10 years and currently has just under 20,000 stores. That expansion took place under the watch of CEO Todd Vasos, who helmed the chain from 2015 until November 2022. He oversaw a Dollar General that consistently grew both its store count and its same-store sales, all while keeping its profit margins fairly stable.
Then, in November of last year, he retired, and the board tapped Jeff Owen to replace him. Since then, Dollar General's business has taken a turn for the worse. Last quarter, the company posted a rare same-store sales decrease, albeit of just 0.1%, with gross margins slipping by 126 basis points. Add on rising labor costs, and the chain's operating profit decreased by a shocking 24% year over year to $692 million for the quarter.
This led to last week, when the board of directors decided to get rid of Owen and bring back Vasos in order to "restore stability and confidence in the Company" (as stated in the press release). The stock price jumped higher on the news, with investors optimistic that Vasos can fix the profitability and growth woes that set in under Owen.
But were those weak results really Owen's fault?
Competitive pressures may be intensifying
It is hard to place all the blame for Dollar General's struggles on Owen. No matter how bad of a CEO you are, the groundwork laid before your tenure contributes significantly to at least the first few quarters of operations after you take the job. Vasos was in charge of Dollar General up until less than a year ago -- and should not be thought of as a white knight who can immediately turn the business around.
Two headwinds seem to be presenting themselves for Dollar General. One of them is short-term in nature, the other much more concerning. From 2020 through 2022, Dollar General's operating margins benefited from a shift among consumers to more discretionary purchases -- likely due to a combination of stimulus checks and higher savings rates -- over consumables such as food. Discretionary items like apparel and household items have higher gross margins than consumables, which propelled the company's consolidated operating margins much higher.
As you can see from the chart below, that bump has now subsided. While we likely won't see Dollar General's operating margin return to COVID-era levels, that shift back toward the prior norms should present much less of a headwind from here.
DG Operating Margin (TTM) data by YCharts.
More concerning is the resurgence of Dollar General's biggest direct competitor, Family Dollar. Owned by Dollar Tree (DLTR 0.04%), that discount retailer posted an impressive 5.8% comp-sales growth rate in the second quarter, significantly outpacing Dollar General. Dollar Tree is currently run by Rick Dreiling, who actually ran Dollar General 10 years ago before Vasos. Dreiling was brought on at Dollar Tree as the executive chairman at the beginning of 2022 and took over as CEO to start this year. In his short time leading the company, Family Dollar has gained market share vs. Dollar General due to the operational improvements he and his team have brought to the business. Dollar General shareholders should be concerned this pattern will persist over the next few years.
Is the stock cheap?
Dollar General shares look cheap if you believe the business will be able to maintain its profit margins in their current 7% to 8% range. With a market cap of $26 billion, the stock trades at a price-to-earnings ratio of just 12, which is around half the S&P 500's average ratio.
However, I think any investor buying at these levels may be under-appreciating Family Dollar's comeback story. The new leadership team at Dollar Tree has just begun its operational improvements, and it won't be surprising to see its chains achieve more market share gains in the coming quarters. Family Dollar's gains could be Dollar General's losses.
Most important may be the management team. Vasos could be a better fit than Owen, but he was the one in charge of this business in late 2022, which is when the decisions were made that led to this year's huge profit declines. For this reason, I think investors should avoid Dollar General stock, even though it's trading at an earnings multiple that's well below the market average.
