No. of Recommendations: 13
I'm also thinking through next steps after 2Q. Unfortunately, I think some of the news in the quarterly report goes to the quality of the enterprise going forward.
Some of my own notes on the 10Q & Earnings Call:
(1) The most concerning item to my eye is that DG's same store sales is stalling (projected -1% to +1%) while its peers are enjoying continued same store growth. It is unclear to me whether the investments now being made to address the inventory and related issues (stores in disarray) are short term costs or the new cost of doing business, i.e., are we looking at a long term drop in profit margins or is this a blip related to certain cyclical and other concerns? My understanding is that DG has a different consumer profile compared to most of its competitors (on the lower end of the income spectrum, with only Family Dollar catering to lower incomes), and with a larger modal store model compared to its peers, to perhaps a 'dollar-to-dollar' comp isn't entirely appropriate, but there is certainly a concern here.
(2) The almost doubling of debt service year over year is having a real impact on profitability. I don't necessarily disagree with the decision to stop buybacks to pay down debt, as the right decision for today, but the decision -- as well as the decision to keep the dividend throughout -- strikes me as a poor allocation of resources, when considered from the long term vantage point. The debt issue could have been headed off in sunnier times. The larger issue I'm having is what to make, if anything, of the change of management. Owen started as CEO in Nov 22, after his stint as COO since 2019. While I think there's something to be said for the fact that we're in very uncertain times, substantial reductions in guidance in two consecutive quarters isn't comforting.
(3) Some of the hit to earnings appears to be the combination of consumers switching to low margin consumables, at the same time that DG is needing to pay higher labour & real estate costs. On the latter point, there was a significant rise in selling, general and administrative expenses, with the company pinning the 1.36% increase on increased costs of "retail labor, utilities, depreciation and amortization, and rent". Much of this strikes me as either cyclical or as issues that DG is addressing via modernization efforts.
(4) DG is still emphasizing the larger store formats (80% of new stores, and all relocations), and is reporting that the larger stores are still "providing better increased sales productivity per square foot as compared to our traditional stores". It's still also expanding aggressively, despite the increase in debt service costs: the forecast for fiscal 2023 is for "3,110 real estate projects in the United States, including 990 new store openings, 2,000 remodels, and 120 store relocations." New store growth is at about 5%.
The optimist in me says that DG has had a very long run of excellent performance, and that the short term stall and then reduction in profits will be but a blip in a few years. If they do get back on track, there's a great base for earnings well in excess of $8 a share.
The pessimist in me is taken by the debt load, the struggles on the labour front, the chain's apparent inability to keep pace with its rivals (e.g., it appears some of the loss of sales was due to Family Dollar undercutting DG on price), and the frustrating lack of clarity on DG's prospects in its Q1 report (only the second under Owen, I believe).
Taken together, a very disappointing quarter. I'm now a little more boom and bust in my opinions about the stock.
Also curious how others are feeling. I am, unfortunately, holding some 2025 call options, and similarly thinking I'll probably roll out at some point, likely with a reduction in exposure more generally.
