Dollar General Stock and ULTA Stock Tank After Earnings. Is the Low End Customer In Trouble?

hey gang welcome to time in the market the investing Channel with a long-term focus is retail dead no but if you look at these earnings uh you might think so Dollar General down 32% yesterday after Q2 earnings that really disappointed and guidance that really disappointed as well we'll talk about that and why that is stock is down 46% in the past 5 years they've really struggled to work through their margin issues and that continues to be the case then we'll talk about Ulta as well really quickly stock is flat for the month Burkshire hathway bought the stock here had a little boost but that's very shortlived as the stock is down about 9% pre-market kind of almost back to where it was pre boost and I think it'll fall a bit more from here but we'll look at those earnings as well and see which one is a more interesting buy if any of them looking at Dollar General Q2 earnings net sales increasing 4.2% doesn't seem that bad same store sales still up 0.5% not amazing but at least it's growing the problem is their margins continue to be pressured EPS down 20.2% % to $1.70 that's a pretty big drop year-over-year and that's a problem so what's driving that well one they blame it on the low-end customer struggling that's certainly the case I think both of these stocks will show that the low-end customer struggling in the mid to high-end customer still doing well you can look at you know Target Walmart Best Buy those earnings were pretty decent so people are still spending money uh and they're just not spending money as much at Dollar General one of the things they mentioned during that call that was interesting is that the last week of the month is their worst week which kind of shows that people are struggling to maintain their purchasing power throughout the month they're running out of money they're having to cut back towards the end of the month the other problem for a company like Dollar General is that their growth is coming mainly from consumables and that's a lower margin item for them in 2021 2022 and this company was still doing pretty well as far as growth as far as margins go really well as far as margins go consumables made up something like 76% of their sales now in this quarter in this half year that we've seen it's closer to 82% so more and more expenses are going towards consumables which are again a lower margin product this is a company that is also adjusting their full year outlook for 2024 down from 6% growth on the bottom end to 4.7% growth on the bottom end 5.3% growth on the top end from 6.7% growth on the top end that's you know not that huge a decrease but the problem is they're dropping their EPS by quite a bit their previous range was 680 to 755 now it's 550 to 620 real pressure on the margin side what is driving that well one their store experience is terrible so people only go there when they have to their business model is basically we're going to build in areas where there's no other options so if you're in a rural area if you're in the middle of nowhere there might be a couple CP of Dollar Generals around you they drive all the other small businesses out of there and they basically raise prices you know drop service hire as little people as possible so you've got boxes piling up in in the middle of the aisle The Experience isn't very good the store looks dilapidated on the inside looks fine on the outside so it draws you in but when you go inside it's not very good it's just not good it's just not a good retail experience so for me even without looking at the valuation I've been to a couple of Dollar Generals and I'm like this place kind of sucks do want to own a place that I think kind of sucks maybe if the valuation is good enough but at the end of the day that's something to consider so on the margin side they did talk about hey we need to hire more people maybe a little bit so that there there's more than one person Staffing an entire store that would be a good idea maybe uh at the end of the day that's going to drive costs up and they're already seeing wage inflation from the under staff stores that they already have they're still planning to open quite a bit of stores they have 2400 real estate projects going on 730 new openings 1600 models some real locations um the interesting thing about this business is that their margins have also been pressured on the Free Cash Flow side because their capex in the last couple of years has basically doubled they they're doing more remodels still about the same amount of openings but a lot more remodels Etc and stuff costs more in general if you have to remodel a store it costs a lot more in 2024 than it did in 2019 and when you're a business that's working on relatively low margins like Dollar General uh that is a problem and that is something that I think is going to be hard to fix I didn't love the call for this earnings company talks about here's all of the things were doing well quite often they're not really talking about the things that they're going to do to fix the problems ahead of them enough and I think what's going to happen relatively soon in my mind is that management is going to be replaced I think they're going to need need a new CEO you don't have a guy like this who's driving such a decrease in stock price stick around for too long in my mind I mean look at what happened with Starbucks I think they just need some fresh blood some fresh ideas because if we look at their growth here it's really slowing down this hasn't really been updated yet but the problem here is is evidently clear when you look at this is a business had 5% free cash flow margins uh for a bunch of time now they're down into the low low single digits I think this is a bit overstated I think these assumptions are a bit optimistic with what's happening with the business on the net income side kind of the same thing you know you're shrinking two to 300 basis points on your margin uh and your growth is dropping into low single digits that's not a good sign as we look at value here disclaimer video is purely for informational purposes only it is not investment advice to your own due diligence so I'm taking it I'm looking at valuation here this is a company that was doing a bunch of BuyBacks and basically they said for 2024 we're not going to do any more BuyBacks kind of a problem when your stock is at fiveyear lows you should be pumping more money into BuyBacks but I think they want to retain Financial flexibility which isn't often a great sign for what's come ahead they still have some debt they have a lot of capital leases on the book so you can kind of see that their market cap is this debt is here to bring an Enterprise Value to 35 billion still not an amazing free cash flow yield based on what happened in the prior 12 if you look at it from a next 12-month basis it's you know closer to 7% which kind of gets more interesting so this is sort of where this is an intriguing Prospect because if they can achieve 3% free cash flow yield in the next 12 months that's a 6.6% free cash flow yield that's about as low as a stock has traded on a free cash flow basis even though they are compressed kind of interesting so as I'm looking at the valuation here expecting growth in the mid single digits this year kind of dropping into low single digits expect free cash flow margins to kind of stay around 3% is that too optimistic let me know in the comments down below is that too pessimistic going back towards a buyback eventually not this year but starting in 2025 this is probably going to be a buyback story if this price stays depressed and if they can achieve you know margins in that 3% range should be good enough they do pay a dividend so keep that in mind about half of their cash flow going out in the form of a dividend as far as I know they didn't raise it last year but I do expect them to kind of raise it minimally for the next couple of years hopefully they don't cut it that would be a big problem for investors but at this point it's paying a 2.8% dividend yield uh if that grows in the low single dig maybe you'll get a 3% cash yield based on today's prices if you buy in the future at 2% growth so at the end of the day that's kind of my assumptions here you can play around with them if you will hit file make a copy the link to this Spreadsheet will be down below uh so 2.7 billion out of the 6 billion in free cash flow going out towards dividends uh about 3.8 billion in accessory cash flow they could certainly Institute a higher buyback than what I'm showing here what's the correct valuation for a company like this historically they've traded in that four to 5% range maybe now that they're slowing I need to up this up to a 6% yield which kind of gets you to a fair value of $68 right now I have it in the 5% yield which is a fair value of 81 bucks so play around with the spreadsheet with this 5% yield I get an expected return of about 11.3% that seems optimistic to me right now the Market's giving this a 6% yield maybe even higher than that on a next 12month basis you know should this be in the 6% free cash flow yield that gets you an expected yield of about seven expected return rather of about 7.9% inclusive of dividends if I want to Target return of 10% prior to dividends gets me to a fair value of 68 bucks a 7 and a half half% return prior to dividends or 10% return after gets me to a fair value of 76 bucks am I interested in buying something like this no I just don't like the product that they're offering right now I don't see myself going into Dollar General and having a good experience I don't see myself I don't see a lot of people going into a Dollar General and having a good experience they go there because they have to however in a recession historically a company like this has done well but right now the the low-end customer is pressured so much that I don't know if they'll do that well in the recession however that low-end customer might actually benefit from you know unemployment Etc depending on who comes into the uh presidential office and the next couple of months you know will food stamps go up customers like this depend on food stamps that might benefit a a company like Dollar General so potential upside from here certainly exists I think what this might be is a good like long-term leaps play if we saw what happened to the stock when a similar thing happened just a maybe a year ago the St cratered from 160 to 100 bucks uh when I last made my video and then kind of recovered pretty quickly to 160 so is a similar recovery ahead for me maybe that'll be worth a long-term leaps like kind of a a lotto play but I don't know if I want to hold this stock long term unless it trades probably closer to the 6 then I'd really consider something like a a position in this stock so that's my thoughts on Dollar General let me know what you think down below looking at Ulta uh similar story here sales uh actually decreasing a little bit or slight actually increasing rather a little bit uh quarter over quarter but comparable sales down 1.2% so new store openings really driving that increase margin pressure coming down as well 15.5% operating margins uh last year 12.9% this year their guidance is impacted as well prior Outlook had them at 11.5 to 11.6 billion in net sales down to 11 to 11.2 comparable sales decreasing to no chain so kind of a problem here for a company like this margins also decreasing so seeing the same thing here basically what they said on the call is there's a couple of factors one the low-end customer is struggling the Marquee Brands the high-end brands are still doing well competition is ramping up and compet means that hey there's over a thousand locations in the last three years that are opening next to where their stores are a lot of competition out there because the high-end customer is the one that's doing well well those customers are more than likely going to stores like Sephora they're less likely going to stores like Ulta Ulta gets more of the low-end customer which is struggling a little bit they talked about how the beauty brand is slowing with growth in the beauty brand down to 3% in in the beauty category rather and this is a category that has been growing for for quite some time at a decent clip so that's coming to a slow and that impacts a company like Ulta for sure especially if that growth is even further cut on the low-end customer they still talked about Brands like elf Etc doing relatively well the growth is there it's just some of their other low-end brands are struggling that combined with the competitive pressure you know you can go Walmart Target CVS Etc but other beauty stores as well to get your beauty products and maybe if the the loan customers struggling they're more than likely to just get their beauty products at other stores or really cut back on the expenditures they make at a store like Ulta which is really impacting them because they're seeing less of that customer they're having to um do some sales that they haven't been doing before that's eating into their margins not really improving sales as they expected them to and that's a problem for a company like this one and I don't think that's something that's going to change anytime soon because the economy is not going to shift on a bubble I mean if anything the economy right now is relatively strong it's just that in certain Pockets like the low-end customer the economy is really pressuring those people quite a bit and that's impacting businesses like Dollar General and impacting a good subset of the business that Ulta gets uh maybe Sephora is doing much better than Ulta that's kind of this the the story that I'm getting out of this as we look at valuation when I last look at the valuation here I was a bit more optimistic but again I think this is going to be a buyback story as well I think Dollar General could be a buyback story if the valuation gets interesting enough I think this could be a buyback story as well you can kind of see that this is a 6% free cash flow yield before the drop already if we cut this by another 10% the cash flow yield on a next 12-month basis is going to be you know closer to 6 and a half% I would wager 6.3% so decent Fair free cash flow yield already as I look at the valuation on the go for forward basis I do have to assume that growth is going to be pretty stale negative 1% growth for the year 2% growth for the next couple of years marges are going to be in that 9 to 10% range what's a fair free cash flow yield for a company like this one I think the story here is going to be that they're still going to generate a bunch of free cash flow even if their growth stalls or even shrinks a little bit the margins here are going to be in that 9 to 10% range hopefully growing throughout this period they're going to put a ton of their money towards BuyBacks I have 50% of their money going towards BuyBacks maybe even more I wouldn't be surprised if it's 75% so if that's the case the fair value gets higher because the buyback yield gets so interesting if the market punishes this more this could get really interesting from a valuation perspective right now at a 6 6 and a half% free cash flow yield it's just okay the question is going to be what's the correct valuation to assign to a company like this one right now I have 75% and the 6% 25% and 5% gets to an expected return of about 88.6% if I want a 10% Target return that's 346 bucks that is higher than what it's trading at pre-market however I could completely see a company like this going down to 6% or even a 7% free cash flow yield in that case you're talking about Fair values in that low 300s High 200s range for me I think if this got into like the 8 to 9% free cash flow yield range I'd get really interested but that means another 20% off of pre-market prices because then this would be a buyback story for me you're getting getting an 8% yield on the buyback side as long as the stock price remains where it is they could push a ton of money into BuyBacks and then it would be a really interesting investment thesis just on that perspective alone and the upside from Return to growth return to margin Improvement Etc would just be the cherry on top it would be a similar thing for me on the uh Dollar General side you know if this gets into the 8% free cash flow yield you know that would be another 20% off of where it is today again I would probably be interested because then it would be a buyback yield I wouldn't have to worry about as worry as much about this business actually performing at a an amazing clip it would just be hey I'm going to buy back a lot of shares as a company and if the business gets back to you know three to four to 5% margins then this could be an amazing return potential company but I I just don't see that happening but if you do you can put hey I'm going to put a 5% margin in here and the fair value is 60% higher than it is trading today if you feel like somehow they can get back to those pre-2020 margins then this could be an amazing company an amazing compounder don't know if that's the case don't know if I believe that but if they can get to you know 20% below where they're trading today and I can get buyback yield that's very very high I could get potentially interested in this uh I wouldn't even mind if they cut the dividend and say we're focusing on Buybacks in that scenario because that would be the the way to play it same with Ulta if they they could get to an 8% free cash flow yield ton of BuyBacks could be an interesting story there as well but for me right now these are both staya aways I think their focus is the low-end customer and I think a lot of science point that that customer is struggling and will continue to struggle for an extended period of time and that will really hurt a bit like a business like these two and I think Dollar in general is just kind of a crappy business so those are my thoughts what do you think let me know down below comment like subscribe all that good stuff uh thanks for watching bye