Cautious consumer-spending behavior was in part to blame. More shoppers filled their basket with necessities such as food rather than higher-margin discretionary products. At Dollar Tree, for example, consumables came to account for 48% of sales, up from 46.2% a year earlier. At Family Dollar, consumables accounted for 80.1%, up from 78.1%. 

And then there were items with no margin at all: Shrink, an industry term for theft, reduced the company’s earnings by roughly 14 cents a share last quarter compared with the same period in 2022. In all, despite lower freight costs, gross margins shrank 3.4 percentage points compared with last year to 30.5%. This follows four quarters of year-over-year expansion in gross margin after Dollar Tree broke its $1 price point and started selling at $1.25.

Those headwinds to profitability were significant enough that Dollar Tree reduced its profit expectation for the year, even as it kept its sales expectations largely unchanged. For the year, it now expects earnings per share of $5.73 to $6.13, which at the midpoint is about 9.5% lower than the midpoint of the expectation it shared in March. Dollar Tree’s shares shed 13% Thursday morning following the earnings call.

The company is still in its early stages of a turnaround led by former
Dollar General
boss

Rick Dreiling,
which involves hefty investments in store improvements and hourly wages. There are green shoots here: Dollar Tree saw its first year-over-year increase in store traffic—and a pretty significant one of 5.5%—after six consecutive quarters of declines. Family Dollar saw its third consecutive quarter of traffic growth. Turnover among employees has improved, and so has service in the stores, the company said on the earnings call on Thursday morning.

Less convincing was Dollar Tree’s assurance that today’s margin headwinds from the shift to necessities-based shopping are temporary. While Dreiling said sales mix will eventually normalize, some of its initiatives, which include introducing more $3-to-$5 frozen and refrigerated food items, could continue shifting its sales composition to lower-margin consumables. An economic-condition-driven shift to consumables has a track record of sticking, at least at competitor Dollar General. Between 2007 and 2010, for example, lower-margin consumables’ share of total sales grew to 71.6% from 66.5% at Dollar General. That proportion continued rising through 2019, when it accounted for 78% of sales. Once shoppers start buying more household essentials at dollar stores, the habit could stick.

Dollar Tree had caught up to Dollar General’s valuation recently in terms of revenue multiple but will now have some more catching up to do. It will have to convince investors that it has a clear pathway to improve profits beyond its breaking-the-buck strategy.

Write to Jinjoo Lee at [email protected]