Trading Near a 9-year Low After a Guidance Cut, Is Now a Golden Opportunity to Buy Dollar Tree on the Dip?

It's been a challenging time for some discount stores. After rival Dollar General (NYSE: DG) saw its shares lose a third of their value late last month following disappointing results and guidance, Dollar Tree (NASDAQ: DLTR) didn't fare much better when it announced its own fiscal Q2 results; its stock fell by more than 22% in the session that followed.

Let's take a close look at Dollar Tree's earnings report and guidance, and see if investors should buy this dip.

Lowered guidance

After investors saw the Dollar General report, it probably shouldn't have come as a huge surprise to them that Dollar Tree was feeling some pressure, too, but the stock got hammered on the news nonetheless. On the earnings call, Dollar Tree Chief Operating Officer Mike Creedon described the current macroeconomic environment as "one of the most challenging" the company had ever experienced.

For its fiscal second quarter, which ended Aug. 3, Dollar Tree's revenue rose 0.7% year over year to $7.4 billion. This was below the $7.5 billion analyst consensus. Same-store sales also rose 0.7%. The Dollar Tree segment's same-store sales were up 1.3%, with traffic climbing 1.4% and average ticket down 0.1%. Family Dollar comparable-store sales were down 0.1%, with traffic up by 0.7%, but the average ticket down by 0.8%.

Similar to Dollar General, Dollar Tree also saw a shift in sales towards the consumable category. Dollar Tree consumable same-store sales rose 4.7%, while they were up 0.3% at Family Dollar. Its gross margin improved 80 basis points to 30%, helped by lower freight costs.

Image Source: Getty Images

However, its operating margin was under pressure due to a number of issues, including increased general liability claims related to settling or litigating claims revolving around customer accidents and other incidents. According to the company, this took a toll of about $0.30 per share on its adjusted earnings. Lower-than-expected sales, meanwhile, sapped its earnings by $0.08 per share. As a result, while management was guiding for adjusted earnings per share of $1 to $1.10 in the quarter, the actual figure came in at $0.67.

When a retailer is struggling, investors should pay attention to its inventory levels, as high inventory levels can lead to even more markdowns. Dollar Tree's overall inventory fell by 4%, while average inventory per store declined by 3.6%, so in that regard, it is in relatively good shape. In conjunction with the fiscal Q2 report, Dollar Tree lowered its full-year forecast.

While Dollar General blamed its own weaker guidance on the pressures being felt by its lower-income customer base, Dollar Tree took it a step further and said that the macro environment was also impacting its middle- and higher-income customers, which it had not been expecting.

Notably, its Family Dollar segment is particularly vulnerable to pressures on low-income customers. On the earnings call, Creedon said that more than 40% of Family Dollar customers are eligible for government assistance.

Is it time to buy the dip?

With both Dollar Tree and Dollar General offering dour outlooks, the troubles the retailers are experiencing are clearly macro-related first and foremost due to the income and inflationary pressures their core customers are facing.

Meanwhile, their business models require these companies to at least appear to be the low-cost leaders, which doesn't leave them with much pricing power. Walmart's success could be hurting them as well. The retail giant is ultimately the brick-and-mortar price leader in the consumables space.

That doesn't mean that Dollar Tree doesn't have room to improve, however. It has been seeing a nice uplift from stores that have implemented its new multi-price format. Stores that introduced that concept in Q1 and had their full fall assortments saw, on average, a 6.7% consumables comparable-store sales increase and a 2.6% discretionary comps improvement.

This new strategy diversifies the company's product offerings, raises its highest price point up to $7, and comes with better gross margins. Management noted that only 15% of its current SKUs are multi-price, so there is a long runway for potential growth with this strategy.

The company is also working to modernize its IT systems and supply chain to help improve gross margins. It is also looking at strategic alternatives for the Family Dollar chain, which skews toward lower-income customers than its namesake stores.

DLTR PE Ratio (Forward 1y) data by YCharts.

The stock is now trading at a forward price-to-earnings (P/E) ratio of only about 9.5 based on analysts' estimates for next year -- around its lowest valuation in the last decade.

With Dollar Tree's shares in the bargain bin and its multi-price strategy showing some early signs of success, I'd be a buyer of this stock on the dip.

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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Walmart. The Motley Fool has a disclosure policy .