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DG Steps Into Spotlight As Discount Retailers Show Strength

The recent troubles in the retailing industry have been widely reported, both on this site and elsewhere in the media. But beyond headlines of disappointing sales, restructuring and bankruptcy worries, there is a more complicated picture.

The hardest-hit portions of the retailing sector in recent months have been department store chains and mall-based retailers. Elsewhere, however, there are signs of strength. One such area is in the low-price field, where two major players - Wal-Mart (WMT) and Dollar Tree (DLTR) - have already announced better-than-expected quarterly results.

That sets the stage for Dollar General (DG), another major player in the group, who is still two weeks away from the release of its quarterly report. The options market is already pricing in notable volatility for DG, as expectations rise for a noteworthy report from this chain of discount stores. The report will follow a string of disappointments from the company, which has issued back-to-back weak reports.

Earlier this week, we previewed the earnings report from Dollar Tree, one of Dollar General's major rivals, which announced its quarterly results Wednesday morning. In that post, we pointed out that, despite signs of problems in the overall retail environment (see Sears Holdings (SHLD) and J.C. Penney (JCP) for examples), there were signs that the situation for low-cost retailers was much better. Wal-Mart (WMT) had posted better-than-expected earnings earlier this month, and Dollar Tree was projected to post higher earnings and improved revenue.

The results for Dollar Tree were even stronger than expected. The company earned $1.36 per share, a notable improvement from last year and above the $1.32 per share analysts were predicting. The company's revenue was basically in line with the consensus estimate of analysts, climbing about 5% to $5.64 billion. The strong quarterly report prompted a nearly 5% rise in Dollar Tree's stock price in pre-market trading.

This sets the stage for Dollar General's earnings in a couple weeks.

Implied Volatility for DG has been rising ahead of DLTR's earnings. IV took a step up in late December and then renewed its advance in late January. IV has risen through most of February, reaching 40.8 this week. This marked its highest level in over a year, topping the 40.5 reached in late November, just before its last earnings announcement.

Dollar General is scheduled to release its next quarterly report on March 16. Earnings are expected to rise to $1.42 per share, compared to $1.30 per share in the same period last year. Revenue is projected to rise to nearly $6 billion, which would represent an increase of nearly 13%.

In its last report, released on December 1, Dollar General reported third-quarter earnings that came in below analyst estimates. The company also provided disappointing guidance. The company's profit fell to $0.84 per share compared to $0.86 per share in the same period last year. Revenue fell 4.9% to $5.32 billion. The company also said that its full-year earnings growth is likely to be at the low end of its long-term forecast.

The release of the last earnings report prompted a 5% drop in the company's stock. The move was less extreme than the option market had priced in ahead of the release. The implied straddle headed into the report was 6.7%. This was the second consecutive report from Dollar General that prompted a negative market response. Last August, shares plunged nearly 18% after its second-quarter earnings came in below expectations.

Historically, Dollar General has tended to have relatively subdued responses to earnings reports. Over the last three years, the post-earnings moves from DG have come in below the pre-report expectations in nine of the 12 quarters. However, two of its more extreme moves have happened over the last four quarters, including the August report. The average absolute post-earnings move over the past four quarters is 9.5%, compared to an average implied straddle headed into the reports of 5%.

The ATM Straddle premium for DG for the March 17 expiration date, which will include its next earnings announcement, is $5.75, or 7.9%. Looking longer term, the premium for the May 17 expiration is $8.37, or 11.5%. For January 2018, the premium is currently at $16.16, or 22.1%.


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