When we last wrote about grocery retail, we observed that 2024 would be a difficult year for the industry. However, it’s not just grocery, as many essentials retailers could also face a down year in terms of sales growth, including dollar stores, pet retail, and auto-part retail.
What all of these categories have in common is that growth for the past three years was inflation-driven versus unit-driven. With inflation rates for goods now flat-to-down, sales growth has become challenging because there just isn’t enough unit growth to go around to meet all the brands’ revenue growth expectations. The next phase of the cycle is highly likely to be discounts and promotions to win share and secure loyalty. We are seeing ample evidence of this in grocery retail and superstores. Next up, pet food and auto parts? An increase in discounts and promotions back to, or above pre-pandemic levels that will lower these industries profits, cash generation, and returns. Given these industries’ ubiquity, that has longer term implications for commercial real estate.
Auto Parts
Advance Auto Parts has had a difficult two years having been “cracked by the executors”: AutoZone and O’Reilly. For its Feb-April quarter, comparable sales declined by 0.2% and gross margin also declined. Operating margin was maintained (at a depressed level of 2.5%) through a significant cut to corporate headcount and marketing. On this week's update call, Advance's management team was careful to note that they had “reinvested in field wages and training,” which indicates that these were previously not competitive, resulting in labor turnover and suffering service levels. As such, we now know that this was one area that the prior management had underinvested which likely is reflected in the market share losses versus the "executors" as shown in the comp table below (evidenced by the sharp slowdown in the two- and three-year comparable sales CAGRs). Auto part prices have been essentially flat since last year, and down 1% (deflation) for the past two months.
On his update of the business and his turnaround plan, Advance Auto Parts CEO Shane O’Kelly shared, “We're also beginning to see benefits from the $50 million reinvested into our front line, including a more than 50% reduction in our district manager turnover, and we expect to see improvements in other key roles throughout the year...Regarding our third decisive action on organizational changes, we are excited to announce that Bruce Starnes is joining the Advance team as Executive Vice President and Chief Merchant.” (Starnes joins from Target where he was responsible for the strategy, capability, and execution of Target’s merchandising operations, including price and promotions, in-store presentation, etc.) Work continues to modernize Advance’s IT, inventory, and supply chain systems, and from the earnings call, it seems like they are going to mimic AutoZone’s hub system to enhance inventory availability and service speeds. The commercial side of the business (compared to do-it-yourself, or DIY, business) is where management focuses its efforts.
Advance Auto Parts CFO Ryan Grimsland stated, “I'm confident the restructuring to align our pricing and merchandising teams will help provide the appropriate discipline to ensure success. In Q2 2024, we continued our merchandising excellence initiative, including securing lower pricing from our vendors, assessing our assortment and its availability as well as reviewing how we are priced in the market.” This tells one that the prior management hiked pricing too high to boost profitability. Given Advance’s low operating margin rate (2.5%), resetting their price positioning and perception will require a lot of central cost take-out and process restructuring. Advance is counting on unit growth and market share to drive sales. We’ll see if that happens; should they fail to achieve both, profitability will fall and the pace of store closures will accelerate. Added to the pressure is the need to add experienced personnel to their accounting and finance department: a so-called “material weakness” and also the result of prior cost “savings” initiatives. Recall that Grimsland replaced the prior CFO last November.
Below we show traffic trends for the three major auto parts retailers. Recall that this traffic primarily reflects the DIY business as commercial is served by the stores’ delivery trucks delivering products to the customer repair shops. The category is 50% DIY and 50% commercial. O’Reilly’s traffic growth figures are flattered by its +2.8% store growth. AutoZone and Advance are roughly flat year-over-year. AutoZone’s business is more dependent on DIY (70%) and so traffic growth is an important contributor to overall comp-sales growth. As is shown, Advance has lagged its peers nearly every week, but broadly positive this year which is an improvement from the declines last fall and winter (i.e., it’s better but not at these peers’ level). Regarding commercial comps for the quarter, Advance's comparable sales increased by low-single-digits, O’Reilly increased by a mid-single-digit pace, and AutoZone increased +3.3%, again behind and losing share.
Dollar Stores
Expectedly, Dollar General reported a tough quarter where profit declined by a quarter due to higher shrink, higher markdowns, lower markups, adverse category mix, higher labor costs, and higher repairs & maintenance. Given all of this, it’s not surprising that 99 Cents Only didn’t see a way through 2024, which we previously wrote about. Favorably for Dollar General, traffic increased, and it outperformed overall comparable sales (+2.4%) as average ticked declined. Additionally, the rate of decline for general merchandise moderated. That said, traffic was softer in April, as was the case across retail, but particularly for retailers serving lower-income consumers. (We show this in the table below on a year-over-five-year basis to strip the impact from the earlier Easter and weather.) For the quarter, the improvement in comparable traffic/transaction improved to “more than +4%” from “nearly +4%” last quarter, so the comparable sales trends likely reflect Dollar General’s new initiatives such greater value, improved service and in-stock levels, lower store manager turnover, and enhanced store standards. Given these investments and the improved execution, as well as Walmart’s ongoing momentum, makes a tough set up for Family Dollar. Family Dollar’s traffic is negative for April and May. (We’ll report on their next week’s results.)
Dollar General's “more than +4%" increase in comparable traffic was somewhat offset by fewer units per transaction (UPT) and a slight decline in average price. The fewer UPTs reflect the trend of households shopping multiple banners to find the best value, cherry-picking promoted items, and efforts to manage cash. (See our analysis here and here on the trend). Also, recall that Walmart and Target are cutting prices in both grocery and general merchandise to drive units and take market share. Additionally, grocers like Albertsons are leaning into app-delivered loyalty programs and deeper offers which are driving market share.
Dollar General needs to match those actions, thus, the reported lower initial markup which hit the gross margin, as well as lowering the gross margin for the year to allow for an increased cadence of promotions and depth. Dollar General CEO Todd Vasos discussed the consumer as, “very value-oriented in their shopping behavior, which we see manifested in accelerated share growth in private brand sales as well as increased engagement with items at or below the $1 price point. Importantly, we continue to do well with our core customers while growing with middle- and higher-income trade-in customers from adjacent cohorts.” That income call-out implies weaker results by lower-income households which we foresaw as noted above.
Theft-shrink has been a large and disruptive headwind for most retailers, and Vasos had big news on Dollar General’s mitigation efforts, “Shrink continues to be the most significant headwind in our business and we are deploying an end-to-end approach to shrink reduction across the organization, including efforts in our supply chain, merchandising and within our stores...Within our stores, we are focusing on delivering a more consistent, front-end presence, and broadening the reach of our high-shrink planograms, which include the removal of high-shrink SKUs and the elimination of self-checkout in the vast majority of stores. As we discussed on last quarter's call, we converted approximately 9,000 stores away from self-checkout during the quarter. Following the quick and successful conversion of these stores in Q1 2024 and given the ongoing challenge from shrink, we converted approximately 3,000 additional stores away from self-checkout in May, bringing us to approximately 12,000 conversions completed in total. While this represents a significant change in our stores, we believe this is the right course of action to drive increased customer engagement while also better positioning us to begin reducing shrink in the back half of '24 with a more material positive impact expected in 2025. Moving forward, we plan to have self-checkout options available in a limited number of stores, most of which are higher volume and low-shrink locations."
Lastly, Dollar General reduced their new store opening plan by 70 locations (730 from 800) and increased its remodel plan by 120 (1,620 from 1,500). For reference, the prior pace was 1K new units per year. Also, there was no discussion of pOpShelf on the call. Below we've expanded our previous Georgia-market visit per location analysis to look at trends on a nationwide level. As shown, pOpShelf is not converging on its incumbent in-market competitors; in fact, its performance gap is widening. Given all of the challenges facing the dollar store industry, we suspect that pOpShelf may be converted into Dollar General locations or addressed in some other fashion.
Specialty Pet Retail
Petco recently reported more stability in its business, but one that is still challenged. Comparable sales were down -1.7%, and margin rates and profits are down leading to cash burn, concerning to its over debt-burdened balance sheet. Like dollar stores and mass merchants, Petco’s sales mix is still upside down with comparable sales declines in supplies (-6.8%) and the companion animal business (where the basket margin is made). Similar to grocery, pet food inflation has passed, and the company’s consumables business was roughly flat (i.e., little price, no volume, down traffic). (Recall that Petco moved its price points and mix too high during the industry’s ebullient 2020 and 2021 period, as did others, which resulted in significant consumer defection to mass/club over 2022 and 2023). Overall, gross profit dollars were down -4% year-over-year, whereas SG&A expenses were up +3%. A replacement CEO has yet to be named; however, the senior management departures continue, including Chief Operating Officer Justin Tichy and Chief Merchandising and Supply Chain Officer Amy College.
On efforts to stabilize the business, interim Petco CEO Mike Mohan said, “We have restructured Petco's executive leadership team...we've simplified decision-making, aligned our focus on fewer and clearer priorities and empowered the organization to move with greater speed and agility. Retail fundamentals falls into the following distinct components. The first is store productivity. In our pet care centers, we've begun to roll out the new store operating model. This builds on the work started last year and reinforces an owner's mindset. The model not only promotes prioritization and increases customer-facing time, but also educates and empowers store partners to create a world-class customer experience and drive share of wallet.
The second area is merchandising excellence. We are conducting an end-to-end review and rationalization of our pricing and assortment strategy across our merchandise mix, designed to improve traffic basket and overall quality of sales. This review is focused on better aligning our in-store and online merchandising to meet the need of all pet parents while driving long-term profitable growth. This will be supported by the third component which is increasing marketing effectiveness. As we plan now for the balance of the year, we are recalibrating our marketing efforts to deliver more effective lower-funnel marketing and engaging actively with pet parents to drive traffic to our stores and online channels. We are partnering with vendors to increase top-of-funnel marketing, reinforcing our unique ability to cater to every pet and pet parents need. And finally, disciplined inventory management.”
As shown in the chart below, the two largest pet specialty brands lag the industry again in 2024. Leading the industry is vet care like Banfield Pet Hospital, dog spas like Dogtopia, and higher-end pet specialty like Chuck & Dons. (Vet services and grooming was strong for Petco, up 10% year-over-year during Q1 2024, but that is lower than last year’s 20%-plus growth rate.) The outperformance of these brands is more aligned to the affluent, and that is also mimicked by the bifurcation in department stores (high-end recovering, middle-income and below under pressure), which we write about below. As such, for specialty pet retailers’ trends to improve, non-affluent discretionary spending needs to flow more freely, or the brands need to attract the affluent consumer. However, doing the later costs more in service levels and store standards (something that’s difficult for their current balance sheet to support), while also risking alienating the middle-income consumer if the retailers were to change to brand and merchandise marketing message to promote a more premium positioning. To conclude, it looks like general pet specialty retail, like auto part retail and dollar stores, is also in for a dog of a year for 2024.
