Sometimes, you can have too much of a good thing. Dollar General Corp. (NYSE:DG) is learning this lesson the hard way. After a disappointing first-quarter earnings report, DG stock plummeted 9.4%. Just prior to the report, shares were up nearly 4% year-to-date.
Needless to say, the substandard performance shocked Wall Street. Before we dive into the details, let’s consider the broader framework. After the 2016 presidential election, Americans were rightfully concerned with a man that had no prior political or diplomatic experience. But from a purely objective perspective, President Donald Trump has pleasantly surprised.
The economy didn’t fall off a cliff like many feared. Instead, we have multiyear record lows in unemployment. And while critics argue that former President Obama was really the driving force, let’s give some credit where it’s due. Since Trump’s inauguration, unemployment dipped from 4.8% in January 2017 to 3.9% in April 2018.
Not only that, consumer sentiment is standing on multiyear highs. Thus, it’s not just that Americans have more money in their pocket — they want to spend it, too!
In theory, these bullish tailwinds should boost DG stock, and its rival, Dollar Tree, Inc. (NASDAQ:DLTR). Just one day prior to Dollar General’s earnings release, MKM Partners‘ Patrick McKeever went to bat for the discount retailer. He argued that “the macro backdrop, including low unemployment and higher paychecks via the new tax law, is supportive for dollar stores’ consumers.”
It sounds very reasonable, and McKeever’s argument aligned with what Wall Street expected. But respectfully, this thesis was flawed from the get-go, and it contributed to the DG stock volatility.
DG Stock Misses the Top and Bottom, But Don’t Forget the Bigger Picture
Now, don’t get me wrong: whenever you miss on both the top and bottom line, you’re likely to face trouble in the markets. Under such supposedly supportive macro conditions, investors expected more out of DG stock.
That’s totally understandable. But in all honesty, the misses weren’t really that awful. What market participants didn’t like was that it became clear that the improved economic conditions are actually not bullish for DG stock; instead, they represent a significant challenge.
For Q1, consensus estimates pegged Dollar General’s earnings per share at $1.40. Unfortunately, DG stock came in at $1.36, or a less than 3% negative surprise. By itself, that doesn’t justify an almost double-digit share price plummet. After all, DG produced a 33.3% year-over-year EPS improvement.
It’s the same story for the revenue front. Analysts expected the discount retailer to haul in $6.189 billion. Actuals delivered “only” $6.115 billion. We’re talking about a difference of only 1.2%. The more important and relevant news item is that sales improved 9% YOY. Furthermore, same-store sales improved 2.1%.
If guidance was the issue, I still don’t see the justification for the sudden drop in DG stock. Management reiterated its expectations for the full-year, still anticipating a 9% YOY sales lift. So what gives?
The problem is that discount retailers are out of favor in strong economies. Just look at what happened to Dollar Tree for its Q1 report. Analysts broadly considered its earnings results disappointing, missing on earnings and revenues. Like DG stock, Dollar Tree’s misses were relatively small. Yet DLTR shares a mind-numbing 14.3%.
Believe me, this has nothing to do with the metrics. Trump’s revitalized America has no use for these businesses.
Why Go to Dollar General When You’re Rich?
In my March write-up for Dollar Tree, I jokingly stated that the company “needs Trump to make America poor again.” Why go to a dollar store if you’ve got the money to go somewhere else? To sum up my argument, I wrote:
Moreover, consumer sentiment indicates Americans are willing to pay for more premium goods. That spells trouble for Dollar Tree stock, which depends on a healthy stream of tight-fisted people.
That’s why I was confused when McKeever stated that an improving economy is good for DG stock. Maybe that’s the case for Kroger Co (NYSE:KR), Sprouts Farmers Market Inc (NASDAQ:SFM) and Whole Foods Market, but not DG.
Perhaps one of my strongest arguments is Ollie’s Bargain Outlet Holdings Inc (NASDAQ:OLLI). OLLI shares are tearing it up this year, and it’s due to their smart business plan. They sell out-of-season or slightly dinged-up brand-name goods for a discount. In other words, they sell quality goods at a discounted price.
Dollar stores? They sell cheap stuff at a cheap price. When you’re hurting or you’re desperate, you may resort to imitation cheese. All I’m saying is that when you have money, you’ll gladly pay for the real thing.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.