3 things Dollar General just isn’t talking about the company right now

There’s no denying it Dollar general‘S (NYSE:DG) the second quarter was just bad. Not only did the company’s results fall short of analyst expectations, but same-store sales growth was anemic and profits fell year over year. The company also referred to its estimates for the entire year. For all this, the company was duly punished.

However, there are a few details that Dollar General may also want to consider before deciding to stick with its pessimistic conclusions. In fact, there are three main reasons why investors should invest in Dollar General stock when it is heavily discounted.

1. The decline in sales in the last quarter was temporary

The discount retailer’s revenue actually grew 4.2% in its fiscal second quarter ended Aug. 2, but almost all of that growth was due to new store openings. Same-store sales (revenues from stores open at least a full year) increased just 0.5%. For comparison Walmart (NYSE: WMT) reported same-store sales growth of 4.2% in the comparable quarter, while Objective‘S (NYSE: TGT) the increase was 2%.

According to Dollar CEO Todd Vasos, “the weaker sales trends can be partially attributed to a core customer feeling financially constrained.” This view reflects recent comments from executives at many consumer companies, and it is not an inaccurate explanation either. Inflation remained above 2% in the second quarter, the effects of several years of much higher inflation were still being felt, and interest rates were higher than in decades. This is probably why, after months of improvement, the Conference Board’s consumer confidence index fell in June and then deteriorated again in July. In September, the biggest drop in economic confidence came among consumers making less than $50,000 in annual incomes – a core demographic of Dollar General customers who can’t simply “trade up” the same way higher-income shoppers do.

However, this short period of time was a perfect storm of monetary misfortune. Interest rates are currently falling, driven by the Federal Reserve’s cut of the benchmark federal funds rate by 50 basis points (0.5%) in September. Inflation also continues to fall, with personal spending rising in line with higher incomes in August. Gross domestic product grew by 3% in the second quarter, despite the difficult situation.

We still have a lot of reconstruction work ahead of us. However, the lethargy of the last quarter likely marks the absolute nadir in the spending ability of Dollar General’s target consumers.

2. (Some) rivals wither

For the record, Dollar General isn’t the only popular discount retailer. Large Lots at the beginning of September he declared bankruptcy and Dollar tree (NASDAQ:DLTR) announced in June that it was reviewing “strategic alternatives” for the Family Dollar store chain it acquired in 2015. The company has struggled to give Family Dollar everything it initially hoped for, to the point that a potential sale or spin-off is now being considered.

This does not mean that the more than 1,300 Big Lots stores currently operating or the 7,761 Family Dollar stores currently in operation will close. The main reason Big Lots went into Chapter 11 bankruptcy and Dollar Tree began a strategic review of its Family Dollar unit was that their management teams were looking for the best ways to keep as many of these stores open as possible.

However, both rival store chains are clearly on the defensive, suggesting that their management teams may be scattered or reluctant to invest in stores with an uncertain future. These conditions create opportunities for Dollar General to gain some market share.

3. Dollar General stock is undervalued

Dollar General stock is currently down 30% from its late August high and 46% below its March high, and Dollar General stock is simply too cheap to pass up.

Let’s first consider its simple valuation. Valued at just 13.6 times this year’s expected earnings per share of $5.84 and about 15 times next year’s expected earnings per share of $6.32 per share, Dollar General shares are about as cheap as they’ve ever been last decade, during which the company grew like crazy.

DG PE data by YCharts.

Moreover, data compiled by New York University’s Stern School of Business shows that the stock price and earnings ratios of average general merchandise retailers are now over 20, while food retail companies’ stock prices are just under 17 times higher than they were in the past and expected earnings.

Perhaps even more bullish is the fact that Dollar General shares are trading short of analyst estimates. Their 12-month average price target is $98.92, which is over 17% higher than the recent share price.

It’s true that the analyst community still has no idea about this company – most of those writing about it rate the company’s stock as ordinary. However, there are several buy and even strong buy recommendations, and only one is an underweight recommendation. This at least suggests that analysts believe a rebound is possible, even if not guaranteed.

The reward is worth the risk and volatility

Of course, the company still has something to work on if it wants to turn things around, and in the meantime, shareholders face a lot of risk. Investors looking for a more reliable, entry-level holding for their portfolios should move this seller to their watchlists for now.

However, if you have some room in your portfolio for a bit of calculated risk, Dollar General’s potential reward now outweighs its likely downside. Most (if not all) potential bad news is already priced into the stock. The biggest concern is the continued volatility, which will surely become evident as other investors begin to consider Dollar General’s continuing challenges.

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James Brumley has no position in any of the companies mentioned. The Motley Fool covers and recommends Target and Walmart. The Motley Fool has a disclosure policy.