Dollar General-Sparked Selloff Is Overdone

by Ethan Roberts | December 14, 2012 8:45 am

Not long ago, I wrote an analysis[1] about Dollar Tree (NASDAQ:DLTR[2]), noting that of the three major players in the dollar space — Dollar General (NYSE:DG[3]) and Family Dollar (NYSE:FDO[4]) being the others — Dollar Tree has had the strongest relative strength and is the company with the best business niche.

Interestingly, two weeks ago, Dollar General was added to the S&P 500, replacing Cooper Industries (NYSE:CBE[5]). With that addition, it now joins competitor Dollar Tree among the largest and most elite stocks in America. There also was substantial bullish chatter in various financial publications about Dollar General seeing an especially high volume of December calls.

Funny how that kind of talk usually comes at the end of a bullish run-up in price.

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But as November ended, so did the bullish fervor of Dollar General. From an intraday peak of $50.80 on Nov. 30, Dollar General fell to $46.57 by Dec. 10.

The next day, Dollar General reported better-than-expected earnings for the sixth consecutive quarter, coming in at 63 cents per share and beating analysts’ expectations by 3 cents. Sales were up 10.3% to $3.96 billion vs. $3.6 billion a year ago, which was in line with analysts’ views.

However, Dollar General also warned of tougher competition and cautious consumers reducing their spending going forward. DG’s full-year guidance implied that Q4 earnings would be 89 cents per share, falling substantially short of analyst expectations of 94 cents per share.

Predictably, the stock was beaten down more than 7% on the day and hit a low of $42.25 on Wednesday of this week. The stock has since bounced back to $44.95.

Dollar General’s warning also scared investors into dumping shares of Dollar Tree and Family Dollar as well, with FDO down 8.3% and DLTR 4.4% lower Tuesday.

The question remains: Was the trouncing of this sector an overreaction by the street, or simply an adjustment to a run-up in price that is no longer sustainable going forward?

Dollar General’s warning — and the resulting stock haircut — was similar to the one we saw from Dollar Tree a few months ago, when it said higher gasoline prices and cautious consumers were accounting for sales coming in at the lower range of previous guidance for Q3 2012.

Consumers’ attitudes tend to reflect the tone of the news, and with recent uncertainty surrounding the fiscal cliff dominating headlines, it’s not surprising that consumers are being more cautious about where they spend their ever-shrinking dollars.

However, by the same token, when consumers do not feel confident, they are more likely to head to the dollar stores for simple purchases than to more expensive stores, which even include Walmart (NYSE:WMT[6]) or Target (NYSE:TGT[7]). Keep in mind that Dollar Tree’s stock surged 578% during the very difficult economic period between 2009 and 2012.

Perhaps Wall Street has been spoiled by the stellar performances of the dollar stores and is expecting too much each quarter. It seems to be saying: “Six consecutive quarters of beating analysts’ expectations is nice, but what have you done for us lately?”

Looking Ahead

As I mentioned previously, I still favor Dollar Tree over Family Dollar and Dollar General for the long run, because Dollar Tree has the niche of being the only dollar store where everything is only $1, giving it a marketing advantage over the other stores. Additionally, I have been in all three stores, and it is readily apparent that Dollar Tree has wider aisles, a better selection of goods and more organization of its products than its competitors.

But if you happen to own Dollar General, the stock is getting a bounce from oversold levels right now, and that should continue for a while longer. The stock does have some resistance between $48 and $49, where a recent “death cross” of the 50-day moving average dropping below the 200-day MA will create some headwinds for the stock. The stock also has been in a longer-term downtrend since July, when it was above $56 per share.

Looking ahead, I believe consumers will continue to frequent the dollar stores amid despite uncertainties over the economy. The most recent selloff was an overreaction — not the beginning of a bear market — and the sector’s stocks should continue to do well, with Dollar Tree continuing to have the greatest relative strength.

As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.

  1. I wrote an analysis:
  2. DLTR:
  3. DG:
  4. FDO:
  5. CBE:
  6. WMT:
  7. TGT:

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