Hi Alex, good note thanks. What do you think about leverage - any chance DG has to lower store growth to get leverage back under their target? Also do you think there is any correlation between the needed labor investment and the company's push into fresh products and now produce?
Good questions. On leverage and unit growth, I'd say that this will become more likely if we get past 2H 2023 without clear signs that this is temporary; think it's too early to say that now, but we'll see how the base is performing in a few quarters. On fresh / produce (DG Fresh), I'm doubtful that's the explanation for what's happening at this point in time; prior commentary leads me to believe that the incremental labor investment is primary in the stores. Wish I had more definitive answers; I'll keep digging and will let you know if I find anything noteworthy.
Alex - Really appreciate the honest assessment. Curious to get your view. Does this steep drop in margins break the investment thesis? I doubt anyone had EBIT margins dropping from > 9% to < 7% even in the downside case scenarios. I assume most folks had DG as a source of stable earnings through economic cycles. Does it raise any concerns that the business might not be as strong as you initially believed?
To me, it feels like DG is more of a “B” business (names like MSFT, SPGI and V would be examples of “A” businesses). Maybe I am 100% wrong, and this poor margin performance is just the perfect storm combined with management execution errors. But I just am not nearly as confident as I used to be that I could forecast DG earnings. And with all of the operating leverage, even small changes to margins really move the needle.
On a potentially broken investment thesis, I largely agree with your comments; it does raise concerns about the strength of the business, particularly relative to a formidable competitor with a great management team (Walmart). As I've hopefully made clear over the past two quarters, that situation is even more difficult given somewhat ineffectual commentary from DG management. From where I sit today, I still believe this is a competitively advantaged business (that said, DG is not immune to periodic problems, as is true for any business). What I need to see now to reaffirm that belief is an effective response / better relative (sales) performance.
On "A" businesses vs "B" businesses, largely agree again. On forecasting DG earnings, anybody who was highly confident in their ability to do so just faced a rude awakening (the "up and to the right" nature of financial models looks quite silly at times like these). You can also see how a sales / margin miss flows through every part of the thesis: a hit to profitability, a pause to repurchases, lowered unit growth assumptions, a tougher grade by Mr. Market, etc.; it's a downward spiral. So, long story short, I think you make a fair point. DG was, is, and will be in a competitive business.
Are the attributes that contributed to some impressive results over time still (largely) relevant today? I believe so, but that conclusion is up in the air. Thanks again for the great questions.
This is a very minor thing but it'd be helpful if graphs that cross from positive to negative values could have the "0" guide specially marked in some way. The YoY category sales and Quarterly SSS graphs in this post were a little tricky to read; category sales in particular where "seasonal" and "home" spent time bouncing across the border, which made it hard for me to get an immediate visual intuition about while reading the rest of the article.
Hi Alex, good note thanks. What do you think about leverage - any chance DG has to lower store growth to get leverage back under their target? Also do you think there is any correlation between the needed labor investment and the company's push into fresh products and now produce?
Harry,
Good questions. On leverage and unit growth, I'd say that this will become more likely if we get past 2H 2023 without clear signs that this is temporary; think it's too early to say that now, but we'll see how the base is performing in a few quarters. On fresh / produce (DG Fresh), I'm doubtful that's the explanation for what's happening at this point in time; prior commentary leads me to believe that the incremental labor investment is primary in the stores. Wish I had more definitive answers; I'll keep digging and will let you know if I find anything noteworthy.
- Alex
Thanks
Alex - Really appreciate the honest assessment. Curious to get your view. Does this steep drop in margins break the investment thesis? I doubt anyone had EBIT margins dropping from > 9% to < 7% even in the downside case scenarios. I assume most folks had DG as a source of stable earnings through economic cycles. Does it raise any concerns that the business might not be as strong as you initially believed?
To me, it feels like DG is more of a “B” business (names like MSFT, SPGI and V would be examples of “A” businesses). Maybe I am 100% wrong, and this poor margin performance is just the perfect storm combined with management execution errors. But I just am not nearly as confident as I used to be that I could forecast DG earnings. And with all of the operating leverage, even small changes to margins really move the needle.
50W-AT,
You have a knack for asking some great questions!
On a potentially broken investment thesis, I largely agree with your comments; it does raise concerns about the strength of the business, particularly relative to a formidable competitor with a great management team (Walmart). As I've hopefully made clear over the past two quarters, that situation is even more difficult given somewhat ineffectual commentary from DG management. From where I sit today, I still believe this is a competitively advantaged business (that said, DG is not immune to periodic problems, as is true for any business). What I need to see now to reaffirm that belief is an effective response / better relative (sales) performance.
On "A" businesses vs "B" businesses, largely agree again. On forecasting DG earnings, anybody who was highly confident in their ability to do so just faced a rude awakening (the "up and to the right" nature of financial models looks quite silly at times like these). You can also see how a sales / margin miss flows through every part of the thesis: a hit to profitability, a pause to repurchases, lowered unit growth assumptions, a tougher grade by Mr. Market, etc.; it's a downward spiral. So, long story short, I think you make a fair point. DG was, is, and will be in a competitive business.
Are the attributes that contributed to some impressive results over time still (largely) relevant today? I believe so, but that conclusion is up in the air. Thanks again for the great questions.
- Alex
This is a very minor thing but it'd be helpful if graphs that cross from positive to negative values could have the "0" guide specially marked in some way. The YoY category sales and Quarterly SSS graphs in this post were a little tricky to read; category sales in particular where "seasonal" and "home" spent time bouncing across the border, which made it hard for me to get an immediate visual intuition about while reading the rest of the article.
Thank you for the feedback, I'll make those adjustments.
- Alex