No. of Recommendations: 7
there are potential partial 'solutions' on all four.
The shift in sales mix ... I would speculate that a separate issue here is that WMT looks like they are stealing the 'trade down' consumers that have historically traded down to dollar stores in the past. That's a real problem, and I don't know how it gets fixed without substantial investment in the quality of DG stores.)
So a partial solution is a return to a less constrained sub-$35k consumer. If this happens, it is likely to be a tailwind for non-consumable sales, and soften the need for markdowns.
Management wasn't exactly transparent on shrink, but they but did suggest on the call that they expect the issue to be a tailwind starting in 2025, due in part to the lag that attends shrink hitting the reporting. Beyond increasing front-end labour, the solutions appear to include the reduction of high-shrink SKUs, the continuing reduction in inventory, and an increase in store relocations/closures. Maybe runaway shrink is the new normal, and it may well get worse from here, but anything resembling a reversion to even close to normal shrink would be a decent tailwind.
Labour inflation and staffing troubles more generally is a big part of the story and I don't see it being an easy fix.
In an environment where people are feeling pinched, my understanding was that dollar stores should do particularly well, as people trade down to lower quality retail. The fact that their key demographic is getting pinched, and the next level up are not coming to dollar stores but maybe being stolen by other discount retailers like Walmart is in itself pretty troubling. One of the reasons I liked the idea of investing in dollar stores is as a hedge for rough economic conditions, a sort of anti-fragile investment, and if this isn't panning out, for whatever reason, for me that's a big negative.
Shrink and labour costs to me are intimately entwined - of course they could reduce shrink by hiring more people to man the checkout counters and to keep an eye out for what's happening, but that comes at a high cost. Maybe shrink will be a tailwind next year, but how much of that will be eaten up by a labour cost headwind? If they had such low levels of staff before, it was that they thought they could get away with it, and maybe they could, but as social norms change and police take a relaxed approach about theft, or are too defunded to worry about theft, it just may be that the low-labour model of small dollar stores doesn't work as well as bigger stores with better surveillance.
I guess as a non-USAian, I don't have a confident read on these 2 big questions, regarding the attractiveness of dollar stores for people in the middle class that hit harder times, and for this mysterious shrink that is not very precisely described by management. If the low margins were just the result of reversible management errors, the 'return to something like previous margins' idea would make me want to invest before those corrections kick in. Usually, 'this time is different' is not a good way to invest, and maybe poor people will go back to dollar stores and shrink and labour costs will come back down, but I just don't feel confident enough about this.
The other thing to worry about, as if the above wasn't enough, is their high levels of debt. They ran up a lot of debt in 2020-2022, much of it from repurchasing shares at over $200 a share. Now that their shares are at $83, they have $18b in market cap and $18b in debt, with about $1b in interest to pay every year, regardless of their level of sales. With just $2b earnings before interest and taxes, it would only take another 2.5% margin loss to mean they use all their EBIT just to finance their debt load. Perhaps they should suspend the dividend? That might be the smart thing to do, and that might also be the smart time to invest...
