Dollar General's Gross Margin Trends Has Investors Worried

| About: Dollar General (DG)
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Dollar General (NYSE:DG) reported Wednesday a near 11% increase in net sales during its first quarter, but shares still fell more than 7% as gross margins slipped on account of higher markdowns and rising commodity costs.

The Goodlettsville, Tennessee-based discount retailer has more than 9,500 stores in the U.S. For the three months ending April 29, Dollar General posted a 15% increase in net income to $157 million, or $0.45 per share, from $136 million, or $0.39 per share, a year ago.

Adjusted for the repurchase of senior debt and two litigation settlements totaling $13 million, profits for the latest quarter were $166 million, or $0.48 per share, up 14% from the year-ago period's $145 million, or $0.42 per share.

Still, the company pulled in earnings below analyst estimates of $0.50 per share.

Despite a 600 basis point drop in gross margin to 31.5%, Dollar General stood by its full year guidance of a 3% to 5% increase in same store sales, and an adjusted earnings per share range of $2.20 to $2.30, in line with estimates of $2.26. The company's net sales for the quarter rose nearly 11% to $3.5 billion. Same store sales rose 5.4%, compared to 6.7% growth in the prior year period.

Store sales for consumable products, like food and drink, rose 13.6% to $2.5 billion, while seasonal product revenue was up 6.3%. Home products sales increased 4.5% and apparel sales climbed 3.1%.

Dollar General said in addition to higher markdowns in winter home and apparel merchandise, a shift in the sales mix to more lower-margin consumables, and higher transportation costs contributed to the gross margin decrease. The company said the gross margin trends are expected to continue through the second quarter.

CEO Rick Dreiling said:

As I look back on the first quarter, we maintained our focus on serving our customers and worked to hold the line where we reasonably could when it came to raising prices in an environment of rising commodity and fuel costs.

In spite of expected gross margin headwinds, we remain well positioned to deliver on our financial outlook for fiscal 2011 as we invest for the long-term health of the company.

Looking ahead, Dollar General said that the volatility of the economic environment continues to pressure the consumer, impacting the company's cost of purchasing and delivering merchandise to its stores.

The company, which opened 139 new stores in the quarter and relocated or remodeled another 184 stores, plans to open roughly 625 new stores in 2011.

Dollar General's stock on the New York Stock Exchange dropped 9.30% on Wednesday closing at $31.81.

Disclosure: None