Tuesday morning, value chain Dollar General (click ticker for report: ) reported stronger than expected results for its third quarter. Revenue rose 10% year-over-year to $4 billion, roughly in-line with consensus expectations. Earnings, adjusted for a one-time expense, jumped 26% year-over-year to $0.63 per share.
During the third quarter, same-store sales grew 4% year-over-year, down compared to the second quarter, but still a fairly strong growth rate, in our view. The firm’s gross margin fell 10 basis points to 30.9%, though its operating margin increased 50 basis points to 9.1% due to strong cost containment.
While the third quarter was relatively strong, management was cautious about the rest of the year. The company narrowed its earnings-per-share range to $2.82-$2.85 from $2.77-$2.85, which implies low-double-digit earnings growth for the fourth quarter of 2012. Same-store sales are expected to increase 3%-4%, while the company’s gross margin is expected to remain flat or possibly fall.
Management sounded downbeat, blaming price wars and tenuous consumer confidence on lower growth rates. However, we believe other firms may be executing better, and consumers may even be “trading up.” Though November was weak for a number of retailers, sales growth at Target (click ticker for report: ) remained solid (given Sandy and the large base). With auto sales reaching a multi-year high, we aren’t ready to throw in the towel with respect to the American consumer, though the fiscal cliff could weigh on after-tax income if it isn’t resolved.
Dollar General announced it will start selling cigarettes in fiscal year 2013. Cigarettes are not high-margin items, but it will help drive both revenue and gross-profit dollars (though the gross margin may suffer). We remain cautious on the segment going forward, as we think the entire cohort including Family Dollar (click ticker for report: ) and Dollar Tree (click ticker for report: ) look fairly valued.