Dollar General Earnings: Financial Marks Under Pressure Amid Weak Demand, Higher Investment Spending

We plan to lower our $130 fair value estimate on narrow-moat Dollar General by around 10% following its lackluster third-quarter results. The retailer remains under near-term pressure as necessary investments in labor hours and store remodels have collided with weak spending capacity from low-income shoppers. As such, same-store sales increased by a mere 1.3% (underpinned by a 0.3% uptick in traffic and a 1% gain in ticket) and operating margin deleveraged 130 basis points to 3.2%, trailing our 3.5% forecast. While profitability came in slightly below our estimates, we don’t expect to materially alter our outlook for fiscal 2024, which calls for a 4.75% operating margin. Instead, the primary culprit for our planned fair value reduction comes from our more desultory outlook regarding long-term profitability. We surmise that a more concerted effort to improve staffing and store conditions will yield a structurally higher fixed-expense base, while intensifying delivery competition in rural areas from firms such as wide-moat Walmart limits upside potential on pricing and gross margin. As such, we expect to reduce our midcycle operating margin forecast from 7.2% to about 6.5% (versus a prepandemic margin of 8.4%). On a positive note, we think the retailer still has ample opportunity to improve its financial marks from currently depressed levels as we estimate about 200 basis points of margin opportunity could stem from a normalization in shrink, inventory damages, and promotional markdowns alone. As such, we still consider shares to be very undervalued.