DG

3 Reasons to Sell Dollar General Stock

Dollar General (NYSE: DG) performed very well during the early days of the pandemic. Its stores remained open, and shoppers flocked to them to buy basic items like paper towels at low price points.

But lately, things have gone awry. The shares have lost about 39% since the start of 2023 while the S&P 500 has gained 37% during this time.

But the stock-price drop isn't translating into a buying opportunity. Here are three major reasons you should shun the shares.

Store aisle with no shoppers.

Image source: Getty Images.

1. Weak sales

Higher prices have stretched consumers, so they should find Dollar General stores appealing. After all, it sells most merchandise at $10 or less. But that hasn't been the case.

For comparison purposes, a key top-line metric for retailers is same-store sales (comps). And these have been weak.

Comps from Dollar General's fiscal fourth quarter, which covered the period ended Feb. 2, rose a tepid 0.7%. More people visited the store but spent less money, which has been a recurring trend. While getting more traffic is good, it's not great if consumers don't shell out money.

Customers also have a wide range of choices when it comes to value offerings. These include behemoths Amazon and Walmart, which use their size as an advantage to achieve savings that they pass along to shoppers in the form of lower prices.

2. Lower margin

Dollar General has been selling more items in its consumables category. This includes basic necessities like paper towels, toilet paper, and garbage bags. While management intends for these products to draw people to stores, they generate a lower margin than the company's other product groups.

These have become an increasingly higher portion of Dollar General's sales, however. Last year, management stated it grew from the previous year's 80%, but it was less than 77% in fiscal 2021.

Dollar General's gross margin has been affected by other things, too. This includes higher shrinkage (i.e., damaged and stolen merchandise) and markdowns needed to clear inventory.

As the company experiences higher expenses for items like labor, occupancy, and increased credit and debit card fees, profits remain under pressure since the company has difficulty passing these along to customers. Dollar General's fourth-quarter diluted earnings per share (EPS) dropped more than 38% to $1.83.

Management doesn't expect any bottom-line improvement this year. It projects diluted EPS of $6.80 to $7.55, which translates to flat to down 10% from 2023. And that's based on comps increasing by 2% to 2.7%.

3. Less shareholder-friendly

Dollar General has been increasing capital expenditures for items like store openings and remodels. This could pay off down the road, but it's difficult to say right now since sales have been languishing.

Last year's free cash flow (FCF) was $691.6 million, which covered the $518 million of dividends the company paid shareholders. But management halted buying back shares. In the previous year, management spent $2.7 billion on stock repurchases.

Management plans on opening 800 stores, executing 1,500 remodels, and 85 relocations this year. Considering the company's weak comps, I'd wait to see how this pans out before jumping into the stock.

Despite the weak fourth-quarter comps, the market liked the results, particularly the traffic growth. However, the company drew in customers based on low-priced, low-margin items. That's not a key to success at Dollar General. I'd sell the shares and invest in retailers with better opportunities.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon and Walmart. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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