The country’s two biggest dollar stores reported earnings last week and while they weren’t awful, the news sent the shares of Dollar General Corp. (NYSE:DG) and Dollar Tree, Inc. (NASDAQ:DLTR) down 18% and 10% respectively.
What gives? Aren’t dollar stores supposed to be a panacea in a retail industry that’s clearly struggling? Nope. And it’s going to get worse.
Breakdown: DG and DLTR Earnings Reports
Dollar General’s report was clearly the poorer of the two, citing food deflation, lower SNAP participation rates and benefits, as well as milder weather for putting a hit on same-store sales in the second quarter; they came in at very anemic 0.7%, 210 basis points lower than the Q2 2015 same-store sales increase.
At the end of the day, DG generated a profit of $1.08 per share in Q2 2016, 13 cents or 13.7% higher year-over-year. That’s nothing to sneeze at. However, on a total dollar basis, earnings increased by just 8.6% in the quarter. With very little change in same-store sales, gross margins and operating margins, the company delivered earnings growth solely on the addition of 261 new stores during the quarter.
Dollar Tree’s Q2 2016 results were marginally better than Dollar General’s. Its same-store sales increased 1.2% — 120 basis points worse than in the same quarter a year earlier. However, it did a much better job on margins, improving gross margins by 190 basis points year-over-year to 30.3% and operating margins by 300 basis points to 7.1%.
With the Family Dollar acquisition almost completely integrated into Dollar Tree’s business, it finished the quarter with 110.8 million square feet of selling space across 14,129 stores in 48 states and five Canadian provinces. It’s clearly a much bigger business post-acquisition.
The downside in its Q2 2016 report came in the form of full-year revenue guidance. Analysts were modeling for $21 billion. DLTR now expects that to be anywhere from $100 million to $300 million shy of that number.
Although each company faced different issues in the second quarter, they both felt a difficult and extremely competitive retail environment contributed to their respective slowdowns in same-store sales growth.
That would suggest this is a problem of a cyclical nature and not something more permanent. Perhaps that’s why InvestorPlace contributor Dana Blankenhorn wrote immediately after earnings that Dollar General’s stock was a bargain as a result of its double-digit decline in price. He makes some compelling arguments why, including the fact DG is more of a department store than a dollar store serving rural communities lacking in alternatives.
In other words, there’s more to it than selling cheap stuff.
But I believe dollar stores face a much bigger problem — one that has been building for some time — that will soon come to light and the aftermath, as we’ve seen with Sports Authority, won’t be pretty.
In 2013, Forbes contributor Walter Loeb penned an article entitled, “Do We Need 40,000 Dollar Stores?” In it, he questioned the expansion plans of Family Dollar Stores, Inc. (NYSE:FDO), Dollar General and Dollar Tree who seemed to be adding several stores a day across the U.S. and into Canada.
“My main concern surrounding the dollar store sector is overexpansion. It feels like there is a Starbucks everywhere you look, yet it had only 6,866 stores at the end of its fiscal year,” wrote Loeb in Forbes. “I estimate that if some of the projections become reality, the major chains will operate as many as 40,000 dollar stores across the United States. It is a number that may not be sustainable and will result in a battle of survival of the fittest.”
Here is a man that spent more than 20 years working in retail, another 16 as a senior retail analyst with Morgan Stanley and now consults for major retailers in the U.S. and elsewhere. His opinion shouldn’t be disregarded by investors. Here’s why.
Bottom Line on Dollar Stores
Dollar General and Dollar Tree have generated combined revenue for the trailing 12-months of $39.4 billion. At the end of the second quarter, they operated a total of 27,129 stores using 206.9 million square feet of retail selling space. That’s annual sales of $190 per square foot of selling space.
That might not seem like a lot when there are luxury retailers generating $1,000 or more per square foot of retail selling space. However, when placed against the backdrop of the American people, it’s huge.
The U.S. Census Bureau estimates the country’s current population is 324.4 million. Every man, woman and child must spend $121.46 at Dollar General and Dollar Tree this year and more than that next year if these two chains are to continue their phenomenal growth.
Do I think DG and DLTR are headed for the scrap heap?
No, of course not. But when Walter Loeb sounded the alarm three years ago, I’m sure everyone thought he was out to lunch. Well, now you can think the same of me.
No, we don’t need 40,000 dollar stores. We don’t even need 27,129. Invest accordingly.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
