Dollar General (DG 0.48%) reported weak revenue for the second quarter last week, but the top-line miss was only part of the picture and several topics were fleshed out in the conference call that management held with analysts. Let's dive into some of management's comments to see what investors should take away from the earnings call.
1. Dollar General remains committed to acquiring Family Dollar
Despite having its initial offer rebuffed by Family Dollar's (FDO.DL) board, Dollar General is adamant that it will acquire its smaller rival in a value-creating deal:
We remain committed to what we view as a superior proposal for Family Dollar shareholders who would receive a higher value for their shares and all cash certainty. For Dollar General shareholders, the proposed transaction is a significant strategic opportunity to create immediate and long-lasting shareholder value.
-- Richard Dreiling, CEO
Dollar General followed through on its promise by raising its bid to $80 per share, up from its previous offer of $78.50. As part of the revised offer, Dollar General said it plans to divest up to 1,500 stores if antitrust authorities require it and will pay Family Dollar $500 million if regulators block the deal. These points could remove some of Family Dollar's concerns.
Family Dollar said in a press release Tuesday that it would review Dollar General's revised proposal. For now, Family Dollar's board remains in favor of a merger with Dollar Tree.
2. Discounting affects gross profit
Dollar General's gross profit declined 53 basis points to 30.8% of net sales, compared with 31.3% in Q2 2013. Management explains:
Promotional markdowns were the most significant factors contributing to gross margin compression, in addition to the higher mix of lower margin consumables, primarily tobacco and perishables.
-- David Tehle, CFO
In other words, Dollar General lowered prices to boost sales volume. The lower prices, combined with an adverse product mix, led to the lower overall gross margin. This continues the trend of a declining gross margin that has persisted over the past two years.
Dollar General data by YCharts
3. Customers are struggling financially
The steady decline in Dollar General's gross margin may be attributable to declining consumer confidence.
You've heard other retailers say this -- low- and middle-end consumers are continuing to struggle. Data now suggest that out of necessity, many folks have reduced their overall consumption. ... As we move through the second half of the year, we will begin to lap headwinds that have weighed on our core customers.
-- Dreiling
Management believes that all of the uncertainty regarding government benefits -- the government shutdown, curbed unemployment benefits, and reduced food stamp benefits -- has finally come to a head and is causing low-income consumers to cut back discretionary spending. This could explain why the company's gross profitability is suffering amid heavy promotions and why consumers are shifting their spending to lower-priced consumables.
4. Comps slow down
Despite consumer headwinds, Dollar General's same-store sales continue to grow. Management explained:
Comp sales increased 2.1%, with increases in both traffic and average ticket extending that trend to 26 consecutive quarters.
-- Dreiling
Even so, same-store sales growth slowed down after a strong start to the quarter. The metric was up 3.5% through May, before discounting and declining consumer confidence began to weigh on results in June and July. This is concerning, because it could mean that Q3 will see lower same-store sales growth.
5. Full-year guidance remains on track
Despite margin pressure, a slowdown in same-store sales growth, and a struggling core customer, Dollar General still expects to hit its full-year earnings expectations. CEO Dreiling promised that "we remain on track to meet the full year adjusted earnings expectations we shared with you last quarter."
Dollar General's guidance calls for 3% to 3.5% same-store sales growth and $3.45 to $3.55 in earnings per share. Through the first two quarters, same-store sales increased 1.8% and the company earned $1.48 per share. If management's guidance is accurate, then investors should expect business to pick up considerably in the back half of the year.
Takeaway
Dollar General's management team wants you to know that despite the poor operating environment, the company is still on track to hit its annual targets. Although investors may rightly be skeptical of this claim, the continued pursuit of Family Dollar overshadows short-term underperformance in terms of value creation. As a result, long-term investors should focus on the Family Dollar acquisition and what it could mean for the company's long-term earning power.
