What does a rate cut mean for discount retailers? – Dollar Gen (NYSE:DG), Dollar Tree (NASDAQ:DLTR)

When the Federal Open Market Committee (FOMC) voted to cut the federal funds rate by 50 basis points (rather than the widely expected 25) at its September meeting, the S&P 500 continued its seemingly bullish path. skyward towards new all-time highs. Many investors had already factored an expected rate cut into their calculations, which helped drive the market higher for most of this month.

However, while the overall response to the rate cut news was largely positive, the immediate and medium-term impact of the FOMC decision on individual companies is more difficult to forecast. Some industries (home construction and manufacturing) tend to be very sensitive to interest rate fluctuations and could see early benefits from lower rates. Retail is another industry that investors typically consider to be in tune to changes in the funds rate. Higher interest rates make customers less likely to spend their money.

In it discount commercial spaceHowever, the situation is likely to be more complex. Companies like Dollar Tree Inc. DLTRDollar General Corp. Managing directorand five below Inc. FIVE They have faced earnings losses and other major challenges in recent quarters, even as the broader market has reached new highs.

Increase in traffic but decrease in transaction amount

On Dollar General's second-quarter earnings conference call, CEO Todd Vasos highlighted the company's 1% year-over-year increase in customer traffic compared to a modest decline in average transaction amounts. In its second-quarter report, Dollar Tree noted weak demand from its core, low-income customer base for its family-owned Dollar brand.

These results point to the challenges faced by traditional customers of many discount retailers: Lower-income individuals and families have been particularly hard hit by many quarters of high inflation combined with relatively high interest rates. With the price of many items higher than just a few quarters ago, customers have resorted to using credit cards for purchases; Dollar General has said that about a third of its customers reported having at least one credit card in their spending limit, with more purchases of essential items being made with credit cards.

Low-income customers have found discount retailers to be a comparably affordable shopping option, as evidenced by the slight increase in customer traffic mentioned above.

However, as salaries are increasingly stretched, these customers are more likely to focus only on basic needs, and sales of product categories, including home goods and seasonal clothing, have fallen. Dollar Tree reported that sales of consumables increased in the last quarter, helping to improve gross margin.

Rate cuts may help, but not immediately

A federal funds rate cut could lead to a lower prime rate and potentially lower credit card interest rates. Given a shift toward greater use of credit cards to cover shortfalls in monthly budgets, this could have a positive impact on spenders. However, there is no guarantee that card issuers will reduce their rates in conjunction with the FOMC, and any positive impact on consumers will likely be minimized and not immediate.

Similarly, cash-strapped consumers seeking higher-paying jobs may find that cutting rates ultimately leads to a stronger pool of available jobs, as businesses can better pay off loans that allow them to expand their operations. But again, any impact on individual customers will likely be indirect and delayed. And it also remains to be seen the real impact of the Federal Reserve's rate cut on unemployment levels, which have been rising throughout the year.

Adjustment Period for Discount Retailers

Analysts across Wall Street are watching discount retailers with hesitation amid a challenging macroeconomic environment marked by the Federal Reserve's rate cut. Most ratings for Dollar Tree, Dollar General, and Five Below suggest investors are holding onto these stocks, as all three companies lowered their full-year guidance in their most recent earnings reports.

At the same time, the average price targets for each of these companies also suggest that investors believe there is potential to upgrade the stock given enough time and depending on the actual impact of the rate cut. Shares of Dollar Tree, Dollar General, and Five Below have upside potential of 28.2%, 32.4%, and 16.5%, respectively.

Investors should also remember that as prices for many products remain high, discount retailers offer a value proposition that can continue to attract new customers. For example, Generation Z and millennial customers have flocked to discount stores in search of more competitive agreements.

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