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Hurricane damage, freight costs weigh on Dollar General's earnings, execs say

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IFRS 9 Impairment How It Impacts Your Corporation And How We Can Help

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Hurricane damage, freight costs weigh on Dollar General's earnings, execs say

Lingering impacts from hurricanes Florence and Michael will drag on Dollar General's fiscal fourth-quarter earnings, while the retailer expects longer-term headwinds from increased shipping and transportation costs, executives said Dec. 4.

"You look at our footprint, we're particularly dense in coastal Carolinas and coastal Florida as well as in rural areas where a lot of the heaviest damage was," Dollar General CEO and director Todd Vasos said during a conference call discussing the discount retailer's third-quarter earnings.

The costs associated with the damage hit Dollar General's fiscal third-quarter diluted EPS and caused the company to trim its fiscal 2018 earnings guidance, which sent the company's stock tumbling by 8.3% in midday trading Dec. 4 to $102.42 per share.

Florence made landfall on the North Carolina coast Sept. 14, tearing a path of death and destruction across both North Carolina and South Carolina. Michael hit nearly a month later on Oct. 10 and hit much of the Southeastern U.S.

"As you look at the nature of the cost, it was storm damage and repairs [and] inventory damage [that] were the key drivers there," Vasos said during the call.

Combined with other floods and fires, Dollar General booked $19.9 million in expenses for the quarter from the hurricanes. Those charges and other costs will deliver a 4-cent hit to diluted EPS in the fourth fiscal quarter, Executive Vice President and CFO John Garratt said.

Longer term, Dollar General is expecting transportation costs, particularly higher carrier rates, to pressure gross margins in the company's fiscal fourth quarter and fiscal 2019, executives said.

A shortage of truck drivers in the U.S. is forcing companies to pay more for freight or to look for alternatives to offset the increased costs. Gross profit for Dollar General dropped 39 basis points year over year in the third fiscal quarter to 29.5% of sales, Garratt said.

The company is growing its private fleet of trucks to 200 by the end of fiscal 2018, up from 80 at the end of fiscal 2017, and expanding its distribution center network to better offset increased shipping costs, executives said.

"It's hard to say how long the carrier rates pressure will continue, but we feel [we] are very well-positioned with the mitigating actions that we're taking as that stabilizes," Garratt said during the call.

Regarding trade, Garratt said the company has had "a relatively low exposure" to tariffs imposed by the Trump administration thus far. However, in preparation for a possible increase in tariffs, the company is contemplating options such as reducing its dependency on China by diversifying product manufacturing and supply. Presidents Donald Trump and Xi Jinping agreed to a 90-day truce to negotiate trade policies, after a meeting at the G-20 Summit in Buenos Aires, Argentina, on Dec. 1. The Trump administration imposed 10% tariffs on $200 billion worth of Chinese imports effective Sept. 24, which was expected to increase to 25% on Jan. 1, 2019. However, the new agreement will put the previously expected increase on hold, while both countries negotiate new policies.

Dollar General also announced plans to continue its investments in real estate expansion in 2019. The new projects include opening 975 new store openings, remodeling 1,000 stores and relocating 100 stores. While Dollar General has historically focused on rural areas, Vasos said the company is positioning itself to open more store in urban areas in the future.

"It won't be a radical change, it will be a slow methodical change to a little bit more of a heavier metro mix as we continue to build the portfolio out," Vasos said.

On the digital front, the company’s DG GO app, which launched earlier this year, is now live in 250 stores, Vasos said. The app allows customers to apply coupons to products and skip the checkout line by paying on their phones and had more than 20,000 actively monthly users in the third quarter.

Although Vasos did not give specifics on possibly integrating the app into more stores, he said the app has received positive feedback from customers.

"We know that our customers who more frequently engage with our digital tools tend to shop with us more often and check out with larger average baskets," Vasos said.


Credit Analysis
IFRS 9 Impairment How It Impacts Your Corporation And How We Can Help

IFRS 9 is a reporting standard for financial instruments that replaces IAS39 (the previous incurred loss standard) with the introduction of provisions for expected credit losses (ECLs) on all financial assets, such as those held to collect contractual cash flows, or held with the possibility of being sold.

The date for adoption was January 1, 2018 and is mandatory for public non-financial corporations (and financial institutions) across a number of jurisdictions outside the United States, including many European countries.

The two key changes introduced by the IFRS 9 accounting standard are:

  • Calculation and provisions must be performed on all affected financial assets, not just the impaired ones, as per the standard it replaces
  • New expected credit loss calculations

Additional challenges will be presented when making assessments for low default asset classes, and companies may find it difficult to access models and sufficient data history.

Impact for non-financial corporations

Non-financial corporations will have some material exposure to many of the financial assets that are defined under IFRS 9. These include investment portfolios, intercompany loans, lease receivables, contract assets, and trade receivables, as illustrated below and further explained in our webinar on IFRS 9 for non-financial corporates.

This, together with the need to assess losses on performing and non-performing assets, might have a material impact on the profit and loss (P&L) of such companies.

ECL calculations under IFRS 9

The IFRS 9 accounting standard introduces new expected credit loss (ECL) calculations that require more data and new models. The key requirements are:

  • Significant increase in credit risk (SICR): Expected loss needs to be assessed at each reporting period to identify a SICR since initial recognition
  • Explicit macro-economic forecasts need to be considered using factors such as the relevant GDP growth, unemployment rate, and stock market index growth figures
  • Credit risk metrics such as probability of default (PD), credit rating, credit score, and loss given default (LGD) need to be adjusted to point in time (PiT), versus through the cycle (TTC)
  • Calculations need to be extended over the lifetime of the assets for underperforming exposures, or in standardized calculations

General versus simplified approach

When performing ECL calculations for trade receivables, the company can choose to take a general or simplified approach (the company is presented with a choice between the two depending on the type of exposure).

  • The general approach uses the 12-month ECL calculation for performing assets (Stage 1 assets) and lifetime calculation for the assets whose creditworthiness has deteriorated since recognition (Stage 2 assets)
  • The simplified approach uses the lifetime ECL calculation for all performing and non-performing assets

The simplified approach can have a bigger impact on P&L expense, as all losses are calculated over the lifetime of the asset, while the general approach can have more impact on P&L volatility, as assets might move between stages incurring 12-month and lifetime calculations.

How S&P Global Market Intelligence can help

A best practice approach used by many financial institutions, which non-financial corporations can also use to comply with the new provision, is to use the existing TTC metrics and convert them into PiT metrics to reflect the current credit cycle, as well as include the required future macroeconomic considerations.

S&P Global Market Intelligence has developed models and tools to help your business undertake the relevant ECL calculations. These models can also be used to assess the creditworthiness of your counterparties and recovery of your exposure in the context of your core business process such as customer credit, supply chain risk, vendor management, and selection and transfer pricing.

The calculation method involves four steps:

  1. We calculate the TTC metric, i.e. the S&P Global Market Intelligence Fundamental PD, CreditModel™ score, for the concerned entity.
  2. We apply our macro-economic model, which weights user defined macro-economic scenarios to produce weighted average forecasted PDs.
  3. We apply a credit cycle adjustment, which converts the TTC risk metric into a PiT PD, leveraging the difference between observed default rates from S&P Global Ratings’ rated universe over last year versus over the past 30+ years.
  4. In addition, as a best practice, we also offer the option to incorporate market-based forward looking information. This is done by further adjusting the PD with the analysis of PD Market Signals country and industry benchmark trends over the past three months versus the past year.

In addition to this quantitative approach available on the Credit Analytics platform, we also offer scorecards that cover low default asset classes for PD, LGD, and point in time adjustments.

Learn More About Credit Analysis
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