Collapse of general dollar stock markets. Should investors buy or stay away?

general dollar (DG 0.99%) Shares lost nearly a third of their value after the discount retailer issued weak guidance with its fiscal second-quarter results on Aug. 29. The drop sent the stock to its lowest levels in more than five years.

Let’s examine the company’s earnings report and guidance and see if this is an opportunity to buy the declining stock or if investors should stay away.

Consumers with lower incomes are under pressure

For its fiscal second quarter (ended Aug. 2), Dollar General saw its results fall short of expectations. Revenue rose 4% year over year to $10.2 billion, but earnings per share (EPS) fell 20% to $1.70. This was below the analyst consensus of $10.4 billion in revenue and adjusted EPS of $1.79.

Same-store sales rose 0.5 percent, but were below the company’s expectations. The gains were driven by a 1% increase in traffic, although the average ticket at the box office fell 0.5%. Growth came entirely from the consumables category, as the seasonal home and apparel categories saw declines. Consumables are items that buyers use (and buy again) on a regular basis.

Gross margin fell 112 basis points to 30%. The company said the downturn continued to remain a “significant” headwind, although it was making some progress in reducing it. Shrinkage is the amount of merchandise that is lost, damaged, spoiled, stolen, or generally unsalable.

When looking at a struggling retailer, it’s always good to look at inventory levels, as high inventory can lead to more markdowns and even more pressure on the line. On that front, the company’s inventory fell 7% to $7 billion and fell 11% on a store-by-store basis. Non-consumable inventories fell 13% and were 17% lower on a store basis.

Looking ahead, Dollar General lowered its guidance for the full year. Revenue is now expected to rise between 4.7% and 5.3%, with same-store sales rising between 1% and 1.6%. That’s down from a previous forecast for revenue growth of 6% to 6.7% on comparable-store growth of 2% to 2.7%

Meanwhile, it cut its full-year EPS forecast to a range of $5.50 to $6.20, down from previous guidance of $6.80 and $7.55. It said its gross margin would feel pressure from increased promotional discount activity.

The company said its core base of lower-income shoppers was feeling worse than six months ago as higher prices, interest rates and unemployment weighed on the group. About 60 percent of Dollar General customers have a household income of less than $35,000 per year. She noted that in surveys, many of her clients say they’ve had to turn to credit card debt, with about 30 percent maxing out one card.

Image source: Getty Images.

Should investors buy the dip or stay away?

Dollar General’s core customers have been under a lot of pressure in recent years from inflation, and even with inflation starting to moderate, those past inflationary pressures are hitting lower-income households that have taken on credit card debt to cope. High inflation squeezes lower-income families much more than the middle class. This can be seen in the comparatively much stronger T2 results posted by Walmart and Aim.

At the same time, the retailer needs its same-store sales to grow by more than 3% for it to exploit its spending and grow its earnings. The latest guidance cut is now well below that 3% threshold. That means its earnings are likely to be squeezed until it can accelerate same-store sales growth again. Importantly, though, his inventory seems to be in pretty good shape.

In terms of valuation, the company now trades at a forward price-to-earnings (P/E) ratio of only about 12, based on analyst estimates for fiscal 2025 (ending January 2026). It is cheap and well below the valuation it has traded at in recent years.

DG PE report data (forward 1y) by YCharts

Dollar General was thrown into the bargain bin after its earnings report, and the retailer should be able to pull through eventually. However, this will not happen overnight as both a better economy and more normal inflation will need to be seen. About 80% of its business is consumables, so its same-store sales benefit over time from moderate increases in consumables prices.

I would recommend taking an opening position and then looking to buy more of any additional weakness in the stock to take advantage of the long-term strength.