1 Growth Stock Down 69%, Buy Now

Dollar General (NYSE:DG) is one of the country’s most important retailers.

The discount chain is found in rural communities and other underserved markets, meeting a unique need across much of the country. In fact, Dollar General has by far the most locations of any retailer, with over 20,000 stores in the United States and Mexico

Its massive store network and leading position in discount retail fueled the stock’s rise for years, but that has changed amid the pandemic. Inflation has impacted its customer base, hurting sales growth and profits. As a result, the stock is now 69% below its peak just a few years ago.

There is a great opportunity here for investors.

Image source: Getty Images.

Dollar General’s problems

Shares of the discount retailer slumped following its second-quarter earnings report as the company’s sales and profit fell short of expectations.

Same-store sales rose 0.5%, supporting 4.2% year-over-year sales growth to $10.21 billion, falling short of estimates of $10.37 billion. Gross margin fell to 30.0% from 31.1% last year and selling, general and administrative (SG&A) expenses increased approximately 60 basis points to sales to 24.6%.

As a result, operating profit fell 21% year-over-year to $550 million and earnings per share (EPS) fell 20% to $1.70, below the consensus of $1.79. Management also lowered its guidance for fiscal 2024.

Management blamed the poor performance on customers’ “financial constraints,” and there is justification for that. Competitors like Dollar Tree have also faced similar headwinds, complaining about weak consumer demand, as have a host of other companies including Goal, Ross Storesand several specialist dealers.

Wall Street is worried that Dollar General is struggling to keep up Walmartwhich has thrived in recent years thanks to its strong grocery business and omnichannel investments like online grocery pickup.

However, competitive weakness doesn’t fully explain Dollar General’s problems. For example, growth was strongest in consumables, the least discretionary category of goods the company sells. In the fiscal second quarter, consumer staples sales rose 6% to $8.40 billion, but the company reported declines in other categories, including seasonal products, home products and apparel, categories that are generally non-essential.

Management also noted that sales were weakest at the end of the month, a sign that customers were struggling to stretch their budgets.

Sixty percent of Dollar General’s sales come from households making less than $35,000 a year, meaning its customers are particularly sensitive to higher prices and economic challenges. That’s a key difference between Dollar General and Walmart, whose average customer has a household income of $53,000.

Why Dollar General is a buy

The challenging market conditions will not last forever. Inflation has already fallen back toward the Federal Reserve’s 2% target, and the central bank has begun cutting interest rates, which will support the economy and reduce borrowing costs for low-income households.

In addition, management is making changes to improve the business. It involves closing less efficient distribution locations and moving the business to permanent distribution centers. It’s also investing in other improvements, such as hiring more front-end employees and improving inventory levels to make it easier for customers to find what they’re looking for.

Management expects the rest of the year to be challenging, but business should improve at some point, and the stock looks like a bargain at the moment.

Even after a forecast cut, the stock trades at a forward price-to-earnings (P/E) ratio of just 14, which is significantly lower than that of competitor Walmart, which has a forward P/E ratio of 33.

Walmart is significantly outperforming Dollar General and deserves to trade at a premium, but Dollar General appears to be oversold at this point. Even a small improvement in results should lead to a recovery in the share price and a higher valuation.

As inflation falls and interest rates decline, Dollar General could see relief sooner than the market seems to believe.

Should you invest $1,000 in Dollar General now?

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Jeremy Bowman holds positions at Target. The Motley Fool has positions in and recommends Target and Walmart. The Motley Fool has a disclosure policy.