The earnings miss and soft EPS guidance has the stock trading sharply lower today, currently down nearly 10%. There are two primary causes for the disappointing earnings performance and outlook. First, its gross margins continue to be squeezed, dropping to 31.2% from 32.1% in the year ago quarter. Secondly, as it relates to its guidance, DG is planning to make investments in two new initiatives this year: DG Fresh and Fast Track.
On the positive side, the highlight of the report was clearly the company’s same store sales growth, which hit 4.0% this quarter, its best mark of the year (2.8% in Q3, 3.7% in Q2, 2.1% in Q1). DG outperformed peer DLTR, which posted same store sales growth of 2.4% in Q4. This would indicate that DG grabbed some market share during the quarter. Growth was driven by a combination of higher average transaction amount and a bump in customer traffic.
DG was especially pleased with the performance of its home category, which led overall comp growth. In fact, this was the first time in many quarters that non-consumables outpaced consumable growth. There is one caveat to this quarter's strong SSS growth. Namely, the company believes that it benefited from the acceleration of February SNAP payments during the government shutdown. Specifically, it estimates that this added 70 bps to its growth.
The decline in gross margin was a function of a few different factors, including higher mark-downs, lower initial mark-ups on inventory purchases, and a greater proportion of sales coming from the consumables category. On that note, DG has been adding new cooler doors across its store base. As of the end of Q3, it had installed more than 20,000 cooler doors. This is a positive in terms of net sales growth, but it does appear to be having a negative impact on margins.
Rising transportation costs have also presented an issue. During the earnings call this morning, management commented that while it has seen signs of stabilization here, it does anticipate that it could see more transportation cost increases this year. Additionally, DG carried out some forward inventory purchases in Q4 due in part to potential tariff increases. This will have an initial negative impact on margins.
On the topic of tariffs, the company's guidance does not assume any increases in rates or additional tariffs. That contrasts with outlook provided by DLTR, which based its guidance on tariffs being moved higher to 25%. The fact that DG's outlook assumes the status quo could be viewed as an additional risk by investors.
DG is implementing two significant initiatives this year. First, DG Fresh, which is a multi-phase shift to self-distribution of perishable goods -- mostly fresh and frozen. The company believes that this shift will enable it to lower product costs and that it will drive higher in-stock levels of these goods.
The other initiative is Fast Track, which is aimed at boosting labor productivity and improving customer convenience. This transition includes the addition of self-checkout stations in its stores as well as the streamlining of its stocking process through "one-touch unloading.” The company plants to pilot Fast Track in some of its distribution centers and select stores in 2019 and to then determine the best course of action for a broader roll-out thereafter.
These initiatives are expected to cost $50 mln in 2019, which will pressure the company’s SG&A line in 1H19. This, along with the aforementioned gross margin headwinds, is what caused the downside EPS guidance. Longer-term, DG believes these investments will improve operating margins.
Finally, to help ease the earnings pressure, DG also increased the authorization under its share repurchase program by $1.0 bln.