Earnings Call
Dollar General Corp (DG)
Earnings Call Transcript - DG Q3 2022
Operator, Operator
Good morning. My name is Robert, and I'll be your conference operator today. I would like to welcome everyone to the Dollar General Third Quarter 2023 Earnings Call. Today is Thursday, December 1, 2022. This call is being recorded. Instructions for listening to the replay of the call are available in the company's earnings press release issued this morning. Now I would like to turn the conference over to Mr. Kevin Walker, Vice President of Investor Relations. Kevin, you may now start your conference.
Kevin Walker, Vice President of Investor Relations
Thank you, and good morning, everyone. On the call with me today are Jeff Owen, our CEO, and John Garratt, our CFO. Our earnings release issued today can be found on our website at investor.dollargeneral.com, under News and Events. I want to remind you that today's comments include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which may include information about our financial guidance, strategy, initiatives, plans, goals, priorities, opportunities, investments, expectations, or beliefs regarding future matters along with other information that is not solely historical fact. These statements are subject to risks and uncertainties that could lead to actual results differing significantly from what we expect and project. These factors include, but are not limited to, those mentioned in our earnings release issued this morning, along with the Risk Factors in our 2021 Form 10-K filed on March 18, 2022, and any subsequent reports. You should not place undue reliance on forward-looking statements, which are valid only as of today's date. Dollar General is not obligated to update or revise any information discussed in this call unless required by law. At the end of our prepared remarks, we will open the call for your questions.
Jeff Owen, CEO
Thank you, Kevin, and welcome to everyone joining our call. I want to begin by thanking our entire team for their ongoing commitment to serving our customers, communities, and each other. The quarter was highlighted by strong performance on the top line, led by comp sales growth of 6.8%, and included increases in traffic and in market share of both consumable and non-consumable product sales. During the quarter, we experienced significantly higher-than-anticipated cost pressures, including challenges within our internal supply chain, sales mix pressures, and higher inventory damages and shrink, all of which impacted gross margin. We will elaborate more on these cost pressures in a bit. But despite these challenges, we delivered a double-digit increase in diluted earnings per share, along with strong same-store sales growth. As the economic environment continued to evolve during the quarter, we remain focused on serving the needs of our core customer. We continue to see customer behaviors in Q3 that we believe indicate they are feeling increased financial pressure, including reductions in the number of items purchased per basket and in discretionary spending, which was softer than anticipated during the quarter. Customers also continued to shift spending to more affordable options, such as items that are dollar price point and private brands, while also shopping closer to payday at the first of the month. Importantly, we are growing more productive with our core customer as well as seeing an increase in customers with annual household incomes up to $100,000. This growth underscores our belief that our value and convenience proposition resonates with a broad spectrum of customers and will continue to be important to all customers in this challenging economic environment. In turn, we remain focused on delivering value and convenience and continue to feel good about our pricing position relative to competitors and other classes of trade. Further, we remain committed to offering products at the $1 price point, and we're pleased with the strong comp sales performance of these products during Q3, as they collectively outperformed the chain average. With nearly 19,000 stores, located within 5 miles of about 75% of the U.S. population, we believe we are well-positioned to support our customers even in a challenging economic environment. We're building on this foundation, I'm excited to share our real estate growth plans for next year. In fiscal 2023, we plan to execute approximately 3,170 projects in the United States including 1,050 new store openings as we continue to lay and strengthen the foundation for future growth. I'll share more details on these plans in just a few minutes, along with an update on our plans for our supply chain as we continue to support our significant growth. But first, let me recap some additional financial results for the third quarter. Our strong comp sales performance helped drive a net sales increase of 11.1% to $9.5 billion. From a monthly cadence perspective, the comp sales momentum we saw building in Q2 continued into all 3 months of Q3, with September being our strongest month of performance. And I'm pleased to note that Q4 sales are off to a strong start as well. Our Q3 comp sales were primarily driven by an increase in average transaction amount, largely driven by inflation. And as we would expect during a more challenging economic environment, average units per basket were down. As I mentioned earlier, we were excited to see a second consecutive quarter of increasing customer traffic contribute to the growth. With regards to the supply chain cost pressures I mentioned earlier, I want to touch on what happened and the actions we have taken to address these challenges. As a reminder, since the early days of the pandemic over 2 years ago, we have seen demand and sales grow at a robust pace. In addition, the overall mix of products we are shipping has evolved significantly with the growth of our non-consumable initiative in pOpshelf. As our distribution needs grew and evolved, we strategically designed permanent warehouse capacity solutions to support our growth. We plan for them to be operational starting in the back half of this year while making greater use of temporary storage facilities in the near-term. However, as we move through Q3, we experienced unexpected delays in opening additional temporary storage facilities, primarily due to external challenges such as permitting. At the same time, seasonal goods came in earlier than anticipated. The resulting constraints from these factors led to more than $40 million in additional supply chain costs in Q3 compared to what we had previously expected. These costs included retention fees incurred for delays in returning shipping containers, costs associated with inefficiencies in moving freight within our distribution centers, and higher transportation costs as a result of servicing stores from less-than-optimal distribution center alignments. While these issues have resulted in a gross margin headwind in the back half of this year, the team has worked hard to move past these delays with the opening of additional storage and warehouse facilities, which have already begun to relieve some of the capacity pressures. In fact, within the past few weeks, we increased capacity by more than 2 million square feet with the opening of 2 new permanent regional distribution hubs in Georgia and Texas, which will serve as intermediary facilities between import points and the rest of our distribution centers. With the opening of both the temporary and permanent facilities, we believe we are well positioned to drive continued improvement as we move ahead, as we better optimize store alignment with distribution centers, lower capacity utilization within our existing footprint, and improve the overall flow of goods. Of note, these regional hubs will be followed by the opening of our new combination distribution center in Nebraska, which is scheduled to begin shipping by the end of this fiscal year. In addition, our previously announced facilities in Arkansas, Colorado, and Oregon are expected to come online over the next 18 months. Collectively, all of these new distribution centers will ultimately result in a more than 20% increase in total capacity and position us well to support continued growth in the years to come. Overall, while internal supply chain challenges have impacted our EPS outlook for 2022, we believe the significant growth in demand that contributed to these challenges is a testament to the growing relevance of Dollar General. And we are confident in our plans to support this growth going forward. Looking ahead, we remain focused on advancing our operating priorities and strategic initiatives from a position of strength, as we continue to distance and differentiate Dollar General from the rest of the retail landscape. We continue to operate in one of the most attractive sectors in retail. And as a mature retailer in growth mode, our transformational strategic actions have positioned us well for continued success while supporting long-term shareholder value creation.
John Garratt, CFO
Thank you, Jeff, and good morning, everyone. Now that Jeff has taken you through a few highlights of the quarter, let me take you through some of its important financial details, beginning with gross profit. Unless we specifically note otherwise, all comparisons are year-over-year, all references to EPS refer to diluted earnings per share and all years noted refer to the corresponding fiscal year. For Q3, gross profit as a percentage of sales was 30.5%, a decrease of 27 basis points. This decrease was primarily attributable to a higher LIFO provision, a greater proportion of sales coming from the consumable category as well as increases in distribution costs, markdowns, inventory shrink, and damages, partially offset by higher inventory markups. Of note, product cost inflation was greater than anticipated, resulting in a LIFO provision of approximately $148 million during the quarter. And while we believe cost increases are beginning to moderate, we anticipate LIFO will continue to pressure Q4 as well. SG&A as a percentage of sales was 22.7%, a decrease of 23 basis points. This decrease was driven by expenses that were lower as a percentage of sales, the most significant of which were retail labor, incentive compensation, hurricane-related disaster expenses, and occupancy costs. These were partially offset by expenses that were greater as a percentage of sales, including utilities, repairs and maintenance, and travel and training costs. Moving down the income statement, operating profit for the third quarter increased 10.5% to $736 million. As a percentage of sales, operating profit was 7.8%, a decrease of 4 basis points. Our effective tax rate for the quarter was 22.8% and compares to 22.2% in the third quarter last year. Finally, EPS for the third quarter increased 12% to $2.33. Turning now to our balance sheet and cash flow, which remains strong and provides us the financial flexibility to continue investing for the long term, while delivering significant returns to shareholders. Merchandise inventories were $7.1 billion at the end of the third quarter, an increase of 34.8% overall and 28.4% on a per store basis. Similar to the first half of the year, this increase primarily reflects the impact of product cost inflation, a greater mix of higher-value products, particularly in the home and seasonal categories, primarily due to the continued rollout of our non-consumables initiative, and the early receipt of seasonal goods. Importantly, we continue to believe the quality of our inventory is in good shape, and we anticipate that we will begin to see lower levels of inventory growth beginning in Q4. Moving down the balance sheet, we issued $2.3 billion of senior notes during Q3, and we now expect to incur total interest expense of approximately $210 million for the full year, an increase of approximately $53 million over the prior year. Turning to cash flow, year-to-date through Q3, the business generated cash flows from operations totaling $1.2 billion, a decrease of 44%, primarily due to higher inventory purchases. Total capital expenditures through Q3 were $1.1 billion and included our planned investments in new stores, remodels and relocations, distribution and transportation projects, and spending related to the strategic initiatives. During the quarter, we repurchased 2.3 million shares of our common stock for $546 million and paid a quarterly cash dividend of $0.55 per common share outstanding for a total payout of $123 million. At the end of Q3, the remaining share repurchase authorization was $2.5 billion. Our capital allocation priorities continue to serve us well and remain unchanged. Our first priority is investing in high-return growth opportunities, including new store expansion and our strategic initiatives. We also remain committed to returning significant cash to shareholders, to anticipated share repurchases and quarterly dividend payments, all while maintaining our current investment-grade credit rating and managing to a leverage ratio of approximately 3x adjusted debt to EBITDAR. Moving to an update on our financial outlook for fiscal 2022. On year-to-date sales performance and our expectations for the remainder of Q4, we are reiterating our fiscal 2022 full year expectations for net sales growth of approximately 11%, including an estimated benefit of approximately 2 percentage points from the 53rd week, and we are updating our expectation for same-store sales growth for Q4, which we expect same-store sales growth in the range of 6% to 7%, which would result in growth toward the upper end of our previous range of approximately 4% to 4.5%. Turning to gross margin. We've experienced many challenges over the course of this year, including those related to product cost inflation, supply chain dynamics, and the evolution of consumer spending. Since our last update and like many retailers, we have seen an increased headwind from lower-margin consumables, sales mix as customers face growing financial pressure. We expect this headwind to grow in Q4 as our guidance assumes customers continue to feel financial pressures and shift more of their spending to consumable items. And while we are making good progress toward resolving our storage capacity constraints, we expect some of the cost pressures we have experienced as a result of the delays will carry over into Q4, but will be largely resolved by Q1 of next year. Finally, we are seeing a greater headwind from inventory shrink and damages than we anticipated for the back half of this year. Overall, while we are confident in the actions we are taking to address our supply chain challenges, we anticipate the total headwind to gross margin in Q4 from all of these factors will be higher than what we previously contemplated within our financial guidance. With all this in mind, we are updating our EPS guidance. For the fourth quarter, we now expect to deliver EPS in the range of $3.15 to $3.30, which would result in a growth for the full year of approximately 7% to 8%. This is compared to our previous expectation of 12% to 14% EPS for the full year. Both the current and previous ranges include an estimated benefit of approximately 4 percentage points from the 53rd week. And our EPS outlook now assumes an effective tax rate toward the upper end of the previously provided range of 22% to 22.5%. We now expect capital spending for 2022 to be approximately $1.5 billion, which is at the top end of our previously stated range. Finally, our expectations for share repurchases remain unchanged from what we stated in our Q2 earnings release on August 25, 2022. Overall, despite the near-term challenges, we are confident in the business and our outlook for the remainder of the year. While we plan to share 2023 guidance on the Q4 call, we feel good about the sales momentum going into next year, coupled with moderating cost pressures.
Jeff Owen, CEO
Let me take the next few minutes to update you on our operating priorities and strategic initiatives. Our first operating priority is driving profitable sales growth. We are continuing to make significant progress executing against our robust portfolio of initiatives. Let me take you through some of the recent highlights. Starting with our non-consumable initiative, or NCI, which was available in more than 16,000 stores at the end of the third quarter. With over 75% of the assortment at $5 or less, this treasure hunt offering continues to resonate with customers who are seeking value. We continue to be pleased with the sales and margin performance we are seeing from our NCI offering, including market share growth in non-consumable product categories. Looking ahead, we expect to realize ongoing benefits from this initiative throughout the remainder of the year and remain on track to complete the rollout across nearly the entire chain by year-end. Moving to our pOpshelf store concept, which further builds on our success and learnings with NCI. As a reminder, pOpshelf aims to engage customers by offering a fun, affordable, and differentiated treasure hunt experience delivered through continually refreshed merchandise, a differentiated in-store experience, and exceptional value, with the vast majority of our items priced at $5 or less. We recently celebrated the 2-year anniversary of the first pOpshelf store, along with our 100th store opening. And we are pleased to see the concept continuing to resonate with customers. During the quarter, we opened 23 new pOpshelf locations, bringing the total number of stores to 103 located within 9 states. Additionally, we opened 15 new store-within-a-store concepts during Q3, bringing the total number of Dollar General market stores with a smaller footprint pOpshelf store included to a total of 40. We remain on track to nearly triple the stand-alone pOpshelf store count this year, which would bring us to a total of nearly 150 stand-alone pOpshelf locations by year-end. Looking ahead, we plan to nearly double the pOpshelf store count next year, as our real estate plans for 2023 include opening approximately 150 additional locations, bringing the total number of pOpshelf stores to about 300 by the end of 2023. Overall, we remain excited about the pOpshelf concept and our goal of approximately 1,000 locations by year-end 2025. Turning now to DG Fresh, which is a strategic, multiphase shift to self-distribution of frozen and refrigerated goods along with a focus on driving continued sales growth in these areas. As a reminder, we completed the initial rollout of DG Fresh across the entire chain in 2021 and are now delivering to nearly 19,000 stores from 12 facilities. The initial objective of DG Fresh was to reduce product cost on our frozen and refrigerated items, and we continue to be very pleased with the savings we are seeing. Another important goal of DG Fresh is to increase sales in frozen and refrigerated categories. We are pleased with the performance on this front including enhanced product offerings in stores and strong performance from our perishable department. Going forward, we expect to realize additional benefits from DG Fresh, as we continue to optimize our network, further leverage our scale, deliver an even wider product selection, and build on our multiyear track record of growth in cooler doors and associated sales. And while produce is not included in our initial rollout, we continue to believe that DG Fresh provides a potential path forward to expanding our produce offering to more than 10,000 stores over time. To that end, we offered fresh produce in more than 3,000 stores at the end of Q3. And looking ahead, we plan to add produce in approximately 2,000 stores in 2023, for a total of approximately 5,000 stores by the end of next year. Finally, DG Fresh has also extended the reach of our cooler expansion program. During Q3, we added more than 17,000 cooler doors across our store base, and we are on track to install more than 65,000 cooler doors in 2022. Importantly, despite the meaningful improvements we have made to date as a result of DG Fresh, we believe we still have significant incremental opportunity to drive additional returns with this initiative in the years ahead. Turning now to an update on our health initiative, branded as DG Wellbeing. The initial focus of this project is an expanded health offering, which consists of approximately 30% more feet of selling space and up to 400 additional items as compared to our standard offering. This offering was available in more than 3,200 stores at the end of Q3, and we plan to expand to a total of more than 4,000 stores by the end of 2022. As we seek to further connect customers with our expanded health offering, we have recently launched a partnership with a third-party payment platform to allow customers to use health plan supplemental benefits to purchase various health and wellness-related items in their local Dollar General stores. And most recently, I'm excited to announce that we launched a pilot of a mobile health clinic provided by DocGo On-Demand to provide basic preventative and urgent care services at a small number of stores in Q3. We plan to test this offering in select stores over the next few months as we continue to work with customers on how to help bring affordable health and wellness closer to home, while further establishing Dollar General as a trusted health partner in the local community. In addition to the gross margin benefits associated with the initiatives I just discussed, we continue to pursue other opportunities to enhance gross margin, including improvements in private brand sales, global sourcing, supply chain efficiencies, and shrink and damage reduction. Our second priority is capturing growth opportunities. Our proven high-return, low-risk real estate model has served us well for many years and continues to be a core strength of our business. In the third quarter, we completed a total of 798 real estate projects, including 268 new stores, 485 remodels, and 45 relocations. For 2022, we now plan to execute approximately 2,945 real estate projects in total, including 1,025 new stores, 1,795 remodels, and approximately 125 store relocations. Looking ahead, as I mentioned earlier, we plan to execute approximately 3,170 projects in the United States in 2023 across our Dollar General and pOpshelf banners, including 1,050 new stores, 2,000 remodels, and 120 relocations. Our ability to innovate our store formats continues to be an important strength of the business. Approximately 80% of our new stores and nearly all of our relocations will be in one of our larger store formats, which continue to drive increased sales productivity per square foot as compared to our traditional box. With regards to remodels, approximately 80% will be in our DGTP format, which will provide the opportunity for a significant increase in cooler count as well as the ability to add fresh produce in many stores. In addition to our planned Dollar General and pOpshelf growth, we are very excited about our plans to expand internationally, and our goal is to open our first store in Mexico by the end of this fiscal year. As a reminder, these stores will be branded under the name Dollar General and will be located in underserved communities in Northern Mexico. Looking ahead, we plan to have up to 35 stores open in Mexico by the end of 2023, as we look to extend our value and convenience proposition to a customer base that is similar to our core customer in the United States. These stores will be incremental to our planned 1,050 new store openings.
John Garratt, CFO
As we head into 2023, our real estate pipeline remains robust. We see more than 16,000 total opportunities for small box retail stores in the United States, including more than 12,000 for Dollar General stores, approximately 3,000 for pOpshelf, and approximately 1,000 for DGX. With these opportunities and our existing footprint of more U.S. brick-and-mortar stores than any other retailer, we are excited about our ability to capture significant growth opportunities in the years ahead.
Jeff Owen, CEO
Next, our digital initiative, which is an important complement to our physical footprint, as we continue to deploy and leverage technology to further enhance convenience and access for customers. Our efforts remain centered around creating a digital front porch for our customers, as we look to continue building engagement across our digital properties, including our mobile app. We ended Q3 with over 4.5 million monthly active users on the app, and expect this number to grow as we look to further enhance our digital offerings. Our partnership with DoorDash continues to resonate with both new and existing customers as we look to extend the value offering of Dollar General combined with the convenience of same-day delivery in an hour or less. This offering was available in more than 13,000 stores at the end of Q3, and we are very pleased with the year-to-date sales results.
John Garratt, CFO
In addition, we are excited about the continued growth of our DG Media Network. We are seeing significant interest and participation from CPG companies and brands, who are seeking to connect with our more than 90 million unique profiles, especially our rural customers, who represent about 30% of the U.S. After establishing the foundation over the last few years, we are beginning to meaningfully grow this business. As we expand the program and enhance the value proposition for both customers and brand partners, we are increasing the overall net financial benefit for the business. Overall, our strategy consists of building a digital ecosystem specifically tailored to provide our customers with an even more convenient, frictionless, and personalized shopping experience. And we are pleased with the growing engagement we are seeing across our digital properties.
Jeff Owen, CEO
Our third operating priority is to leverage and reinforce our position as a low-cost operator. We have a clear and defined process to control spending, which continues to govern our disciplined approach to spending decisions. This approach, internally branded as Save to Serve, keeps the customer at the center of all we do, while reinforcing our cost control mindset. Our Fast Track initiative is a great example of this approach, where our current goals include increasing labor productivity in our stores and enhancing customer convenience. The current focus of Fast Track is self-checkout, which provides customers with another flexible and convenient checkout solution while also driving greater efficiencies for our store associates. Self-checkout was available in more than 10,500 stores at the end of Q3, and we continue to be pleased with our results, including strong customer adoption rates. We are also excited about our pilot in select stores, which provides customers the option to utilize self-checkout in all lanes, but also choose a staff register, if preferred. We believe this full self-checkout option could further enhance our convenience proposition, while enabling store teams to dedicate even more time to serving customers. We are currently testing this layout in approximately 250 stores and are pleased with the early customer and associate response. Looking ahead, we are on track to expand our self-checkout offering to a total of up to 11,000 stores by the end of 2022, as we look to further extend our position as an innovative leader in small-box discount retail. Moving forward, the next phase of Fast Track consists of increasing our utilization of emerging technology and data strategies, which includes putting new digital tools in the hands of our field leaders. When combined with our data-driven inventory management, we believe these efforts will reduce store workload and drive greater efficiencies for our retail leaders and their teams. We also continue to reduce costs through the expansion of our private fleet, which consisted of more than 1,300 tractors at the end of Q3. As a reminder, we have been focused on significantly expanding our private fleet in 2022, as we plan to more than double the number of tractors from 2021, which we expect will account for approximately 40% of our outbound transportation fleet by the end of the year. Our underlying principles are to keep the business simple, but move quickly to capture growth opportunities while controlling expenses and always seeking to be a low-cost operator. Our fourth operating priority is investing in our diverse teams through development, empowerment, and inclusion. As a growing retailer, we continue to create new jobs and opportunities for personal and professional development and ultimately, career advancement. Our internal promotion pipeline remains robust as evidenced by the more than 70% of our store employees at or above the lead sales associate position who were placed from within. In addition, approximately 15% of our growing private fleet team began their careers with us in either a store or distribution center. We are pleased with our turnover trends and staffing levels. And applicant flow continues to be strong, further validating our confidence that we are taking the right actions to attract and retain talent. Ultimately, we believe the opportunity to develop a career with a growing and purpose-driven company is a unique, competitive advantage and remains our greatest currency in attracting and retaining talent. We also recently completed our annual Community Giving Campaign, where our employees came together to raise funds for a variety of important causes. And I was once again inspired by the generosity and compassion of our people. We continue to add incredible talent across the organization in our stores, distribution centers, private fleet, and at our store support center. As this new talent joins our tremendous team, I am continually reminded that the people of Dollar General are our greatest strength. In closing, I am excited about the future as we continue to make great progress against our operating priorities and strategic initiatives, with the number of initiatives we have in place and a unique and strong strategic planning process, we are confident in our plans to drive long-term sustainable growth, while creating meaningful shareholder value. Finally, as we are in the midst of our busy holiday season, I want to thank our approximately 173,000 employees for their commitment every day to serve our customers. I am excited about our work together as we head into the final weeks of our year.
Operator, Operator
Our first question comes from Matthew Boss with JPMorgan.
Matthew Boss, Analyst
Great. So Jeff, maybe first, could you elaborate on what you think is driving the sequential acceleration in same-store sales? I think traffic has now sequentially improved for the second straight quarter. What are you seeing across the income cohort? And then maybe just looking back at past periods of consumer pressure, how sustainable do you see the market share opportunity in front of us?
Jeff Owen, CEO
Thank you, Matt. We are very pleased with our 6.8% increase in comparable sales. It's encouraging to see traffic accelerate for the second consecutive quarter and to continue growing market share. We have gained market share in both our consumables and non-consumable segments. Our strong sales performance is largely driven by the consumables business, which highlights our commitment to meeting customer needs. This speaks to the relevance of our stores and our ongoing efforts to enhance the shopping experience. It's also noteworthy that our core customers remain employed, which is vital for their economic well-being. We are excited about our ability to improve productivity and market share among this group. Additionally, it's encouraging to see growth across all income levels, especially among higher-income consumers. We've managed to retain more customers than we anticipated from the COVID period, and we are also seeing an increase in customers earning $100,000 or more. This reinforces our capacity to serve various income demographics, positioning us well for future growth. Regarding our consumables business, we are satisfied with its performance. Our strategic initiatives have transformed this segment from a profitability perspective, with our gross margin in the third quarter being 100 basis points higher than it was in 2019. As we look ahead, we are well-prepared to cater to a diverse customer base in the current economic climate. We are also excited to launch more real estate projects in 2023 than ever before, reflecting our strong pipeline and strategic initiatives. Overall, we feel confident about our sales performance and our ability to serve our customers going forward.
Matthew Boss, Analyst
That's great. And then maybe, John, on gross margin and just to break down some of the components. So do you see these warehouse costs and supply chain efficiency as more transitory and contained to the fourth quarter? Help us to think about LIFO going forward relative to the material gross margin headwind this year, should we anticipate should transportation as a tailwind now from here? And just what inning do you see the drivers of inventory markup in today?
John Garratt, CFO
Sure, Matt. I'll start with the question around the supply chain costs. And as we called out versus previous expectations, the supply chain costs were a significant headwind, more than $40 million above our previous expectations for Q3. And we do see this as near-term. And we're making very good progress toward resolving our storage capacity constraints as more capacity comes online. And we do believe some of these cost pressures, nonetheless, will carry over into Q4. However, we do expect this will largely be resolved in Q1 of next year. So as we look ahead, we anticipate supply chain costs, both internal and external in 2023 to be down quite a bit. We're obviously seeing it improving as others market for carrier costs as well. And so that as a potential tailwind going forward. And then LIFO as well. We're seeing the pace that while it will continue to pressure Q4, we are seeing the pace of cost increases continue to moderate. And as we look at next year, we'd expect less pressure from LIFO. So certainly, some near-term pressures between LIFO and the supply chain costs. We also mentioned the sales mix shift and shrink and damages. But as we look to 2023 and beyond, we feel good about, as Jeff mentioned, one, the sales momentum in the business; but also moderating product cost and inflation, particularly around supply chain and LIFO. And as you look at the initiatives, we have that continue to contribute the other levers we have, not to mention our scale and where we're at in price, we don't see a need to invest. We feel that we're very well positioned as we look ahead to the future to continue expanding gross margin over the long term.
Matthew Boss, Analyst
That's a great color. Best of luck.
John Garratt, CFO
You asked about markdowns as well. I didn't want to miss that question. As you look at markdown risk, while up from the unusually low levels last year, markdowns are still well below pre-pandemic levels. If you look at the majority of the inventory growth, it's really driven by inflation. The team has done a good job anticipating the mix shift in consumer demand and has proactively been adjusting orders. And as a result, we feel very good about the quality of the inventory and its ability to mitigate the markdown risk. As always, we've set aside what we believe is an appropriate markdown level for the upcoming Christmas season. And of course, this is all reflected in our guidance.
Operator, Operator
Our next question comes from Simeon Gutman with Morgan Stanley.
Simeon Gutman, Analyst
I have a follow-up question for you, John. This year, you were expecting to grow earnings in line with previous estimates, excluding the 53rd week, but now it looks like it will be lower even though you're generating more sales. There seems to be something unexpected in your business model. I know you’re not providing guidance for next year, but theoretically, there should be some recovery. If there is a recovery, will you allow that to translate into your operations, or do you believe the business will just focus on existing strategies? I'm unsure if it's for reinvestment or if we won't fully see the recovery that I'm alluding to.
John Garratt, CFO
Sure. So as you mentioned, we won't be giving specific guidance on this call. We'll certainly share that on the March call. But I'll just start by reiterating that we feel great about the fundamentals of the business, the sales momentum, coupled with the moderating cost pressures that I just articulated. And as you called out, it is one less week next year that's important to bear in mind. But again, as you look at the fundamentals of the business, they're very strong. We continue to see ourselves as 10% EPS growers over the long-term. Now we will always balance that with investing back in the business for the long-term, but feel we're very well positioned. And more to come for next year, but feel great about the momentum of the business fundamentals.
Simeon Gutman, Analyst
Okay. And maybe my follow-up, maybe sticking with you on fourth quarter gross margin. I guess, we're trying to build to the pieces, supply chain, mix, shrink. And we're having trouble getting to the entire magnitude. Are you willing to share a little more magnitude by item, by driver? Because it doesn't feel like the consumables mix goes up enough to justify the mix. So there seems like there's something like markdown in there as well.
John Garratt, CFO
As we assess the factors contributing to the additional pressure in Q4, they resemble those from Q3, though the order has changed slightly. The main expectations for Q4 margins indicate a healthy flow-through, albeit not as strong as we had previously forecasted. A significant change is the shift in product mix. We have observed a shift toward consumables due to customers encountering financial difficulties. While we want to align with customer preferences and appreciate the sales trends, this does create some margin pressure due to the sales mix. Additionally, as we noted while progressing through Q3, we are facing greater challenges from inventory shrink and damages, which may have lingering effects. However, I assure you that our team is equipped to manage these issues and is taking appropriate actions, even though they may have some ongoing impact. We are making strides in addressing our storage capacity challenges, and while we expect some of these issues to extend into Q4, we anticipate they will be primarily resolved by Q1. This is a notable difference from our earlier expectations. Furthermore, LIFO remains a significant concern. We highlighted a $148 million impact from LIFO in Q3; while we believe the pressure from product cost headwinds is starting to ease, past cost increases will still impact Q4 LIFO, and this will affect our calculations for the entire year. These are the key factors at play. That said, I want to emphasize that many of these issues are temporary. Looking ahead, we feel confident in our ability to restore our gross margin growth in the long term through various initiatives, leveraging our scale, and optimizing our pricing strategy.
Operator, Operator
Our next question comes from Corey Tarlowe with Jefferies.
Corey Tarlowe, Analyst
Congratulations on your sustained revenue growth and market share gains. Could you elaborate on customer behavior as it seems traffic has increased, and customers are visiting stores more frequently and possibly shifting towards private label products? Additionally, can you discuss your investments to support growth in that segment? As the mix shifts further toward consumables, how do you plan to align that with the anticipated growth in NCI, which could enhance profitability moving forward?
Jeff Owen, CEO
Thank you for your question. I want to emphasize that the stable employment of our customers is crucial for economic health. When we engage with our customers, we find that they are feeling the pressure from energy prices and daily expenses, making it difficult for them to make ends meet. As a result, we see them coming to us more frequently and purchasing fewer items each time. We're pleased that we can meet their needs through affordability. Our focus on the one-dollar price point is resonating well with customers. This reflects our team's ability to adapt to customer preferences in terms of price and affordability. In terms of our consumable business, it’s vital to consider our strategic initiatives that have contributed to profitability. We've traditionally used consumables to attract customers and non-consumables to enhance the shopping basket. Our non-consumable items are performing well, particularly NCI, which offers 80% of its products at $5 or less. This strategy helps us drive traffic through consumables while also promoting product rotation and variety. Regarding our private brand, we are pleased with its market penetration, but it's important to note that our customers value certain brands too. That's why leveraging our scale is crucial. As mentioned earlier, our ability to switch brands if necessary allows us to serve our customers effectively. Our customers view a brand as a brand, so this flexibility helps us provide the value they seek. Overall, we believe we are well-positioned and excited about our ability to listen to our customers and meet their needs. With a more profitable consumable business and our strategic initiatives, we're set up nicely to continue serving them through various economic conditions.
Corey Tarlowe, Analyst
That's great. And then thanks for laying out the new store plans for next year. I think that helps to really provide a little bit more color as to the predictability and stability that we should expect ahead. Could you talk a little bit more about the strong returns that you're continuing to see on those new stores? And what we should expect more so from a continued ROIC standpoint as it relates to some of these new stores as we look ahead?
Jeff Owen, CEO
Yes, Corey, I'll start and then I'll let John fill in on some of your questions around returns. But our real estate model continues to be a huge strength of this business. I mean the low-risk and high-return model is incredibly powerful. And when you think about the retail landscape today, when you think about some of the challenges other retailers have talked about on the real estate front, I'm just very, very excited and proud of the fact that we're going to deliver more projects than we ever have at Dollar General in 2023. And with 1,050 new stores, it continues to just highlight our ability to serve the customer and our ability through format innovation, our real estate model, our technology, we're able to go where the customer needs us to go. And so feel great about that. And really pleased at the fact, through format innovation, this larger store we're opening, our new store performance has been incredibly positive. And I'm very, very pleased at our ability to exceed our pro formas, and we continue to see that. So that larger store format is continuing to deliver higher sales per square foot, which is excited. And as you know, the large majority of our openings are in that larger footprint. But as you think about the next year in the future, I think the other thing that excites us here is the pipeline that we have. And on the U.S. alone, we have 16,000 additional opportunities, and we feel great about our ability to capture those. And certainly, our fair share, which we've certainly demonstrated, but 12,000 additional for DG, 3,000 for pOpshelf, and then 1,000 for DGX. So stepping back, you can probably hear in my excitement about the real estate and our ability to continue to grow here. And we feel like we're being very prudent in this environment, I'm very, very pleased with the team's performance here. So I'll kick it over to John for your return question.
John Garratt, CFO
Yes, echoing Jeff's comments, we are very pleased with the results we're seeing. As he mentioned, our sales are above pro forma, which puts us ahead of schedule regarding the internal rate of returns. We aim for a 20% to 22% after-tax internal rate of return based on sales, and as we exceed our sales expectations, that also means we're ahead on returns. It's important to remember that this includes the impact of cannibalization, which remains minimal and consistent due to the localized nature of the shop. We continue to see paybacks of less than 2 years, making this a fantastic investment that we are actively pursuing. We are also very satisfied with the returns from our remodels, and we are not only achieving a record number of overall projects this year but also a record number of remodels, which significantly contributes to our comparable sales growth.
Operator, Operator
Our next question is from Michael Lasser with UBS.
Michael Lasser, Analyst
John, I want to hopefully get some frame of reference on 2 factors that are impacting the gross margin. So, a, you mentioned $40 million of supply chain costs that are above and beyond what you expected, does that go to $30 million in the fourth quarter? And if that's in the right ballpark, you used the term of beat, which you can interpret a lot of different ways. I think what most of the market wants to know is, does abate mean you're going to incur $70 million this year that will go away because those are extraordinary costs next year? And as part of that, the other piece of it is the LIFO, which the LIFO headwind because that's needs to be $450 million or so if we just add $100 million for the fourth quarter. If there's a linear path of this inflation, meaning it goes from 9, 8, 7, 6 so forth, would that LIFO headwind that's going to be, call it, $450 million this year, be like $300 million next year, so you get a $150 million benefit? Sorry for so many numbers and so much confusion.
John Garratt, CFO
Thank you, Michael. I will address each of your points. Regarding the ongoing impact of supply chain costs, we did not provide a specific figure, but we expect it to be lower while still being significant. For LIFO, although we foresee a slowdown in price increases, we assess the full-year impact of known price increases at a specific point in time and distribute that throughout the year. This will help us understand what Q4 may look like. Looking to next year, we expect a substantial decrease in the LIFO figure. We believe supply chain costs will significantly decline as we won't face these one-time costs, which we anticipate will be resolved by Q1. Additionally, the market shows favorable trends for transportation costs, both internationally and domestically. We are also expanding our private fleet, which will yield savings by reducing costs by 20% with each conversion, and we plan to double its size this year. As we consider next year, we are optimistic about several positive factors, despite some challenges. We remain committed to serving our customers and will adapt accordingly. There are ongoing challenges related to shrinkage, which we are actively managing. Looking ahead, there are various factors to consider, but overall, we are confident that many favorable conditions are in place regarding LIFO, supply chain costs, and the initiatives we've discussed.
Operator, Operator
We've seen now some cost pressure at Dollar General. This follows a significant decline in profitability your largest competitor. Should we take these as one-time events? Or is there anything to say that just the overall profitability of the small box value convenience sector is permanently under pressure or long-lasting under pressure because of some of the competitive dynamics? Because of the shift to consumables and other factors? Or would you expect that this is not a trend that's going to be long-lasting?
John Garratt, CFO
Yes, I want to emphasize that we view most of the pressures as temporary. Both the LIFO and supply chain issues are seen as transitory challenges. We remain optimistic about our non-consumable products and consider these pressures to be more of a macroeconomic nature. We are gaining market share and simply aligning with the trend of consumers shifting their shopping preferences from discretionary items to consumables. We believe we will perform well in this area as the economy improves. Structurally, we believe we are well prepared, especially concerning wages, applicant flow, and staffing levels. Our business investments are appropriate, and we feel our pricing strategy is sound. It's worth noting that in Q3, while we experienced a decrease of 27 basis points in gross margin, we are still approximately 1 percentage point above pre-pandemic levels, despite the transitory pressures I mentioned. We remain a point ahead of where we stood in 2019 during Q3.
Operator, Operator
Our next question comes from Paul Lejuez with Citi.
Paul Lejuez, Analyst
Curious on the storage capacity and supply chain inefficiencies. If there was a sales impact during the quarter as well as the cost impact that you talked about. Maybe if you could frame that, also, same question, if you expect there to be a sales impact in Q4? And related to that, was the pressure any region in particular where you saw the cost and/or sales impact? And how much of a differential was there in terms of the performance of that region versus your others?
Jeff Owen, CEO
Yes. Thanks. I'll tell you, as we said before, the delays of our temporary storage facilities, certainly, that unexpected delay did impact the quarter from a profitability standpoint. But again, I reiterate how pleased we were with the strong sales performance we saw. And the nice thing is like it normally is at DG, it's pretty broad-based. And so I think, again, that goes to the consistency of our ability to serve a customer across, not only a broad swath of the United States, but also around the income levels I mentioned earlier. And we're very pleased and excited that our temporary storage facilities are now online. We're also excited that our 2 new permanent regional hubs that are going to serve us extremely well. As we look to the future, they're also online. And of course, those things will take some time to get fully productive and to allow us to catch-up. So again, I would also mention we're pleased that we had in stock improvement year-over-year in Q3. So again, when you kind of bundle it all together, I think the team did a nice job of overcoming some of these challenges, to deliver for the customer, go where she wants us to go. I think that translated into our strong comp, our strong market share gains in both consumables and non-consumables and a second consecutive quarter of sequential traffic increases. So again, feel pleased about the top line and feel pleased about where we have opened up our capacity. And finally, I'll just mention, as you look forward over the next 18 months, bringing on 4 permanent facilities, that will increase our capacity by 20%. And is something we factored into our strategic plan and feel great about how that's going to serve us well and allow us to continue to grow this business in the years ahead.
Operator, Operator
Our last question will be from Rupesh Parikh with Oppenheimer.
Rupesh Parikh, Analyst
So just going back to your commentary on shrink. I was curious if you can provide more color in terms of what's driving the higher shrink lately, opportunities you guys see to reduce that going forward? If there's any way to quantify how you think about the headwind for Q4, or even what you saw in Q3?
John Garratt, CFO
Yes, we observed an increase in shrink towards the end of Q3, which we primarily attribute to the inflationary environment and elevated inventory levels. As you know, the retail sector is also experiencing higher shrink in this situation. We anticipate this trend will continue into Q4. It's worth noting that when we outlined the gross margin drivers, shrink was the smallest factor impacting Q3, but it was later in the quarter. Therefore, we expect a potentially larger impact from shrink in Q4 if the conditions persist. Despite the recent increase, our shrink levels remain low compared to historical data, just not as low as the record levels we achieved previously. Our team is well-equipped to address this, and we are implementing effective strategies. We are increasing tagging for our EAS units, utilizing technologies such as exception-based reporting, and maintaining strong process controls to manage shrink. However, we will likely experience some residual effects until these strategies take effect.
Rupesh Parikh, Analyst
Great. And then maybe just one quick follow-up question. So just on trade-in, I know your team expects trade-in to continue into Q3, and I believe Q4 as well. At this point, is the trade-in you're seeing consistent with what you would expect in a recession? Or would you say it is still below what you typically see in a downturn?
Jeff Owen, CEO
Yes, Rupesh, as I mentioned earlier, we are very pleased to see that we are gaining customers across all income levels, which is encouraging. I want to emphasize the relevance of our brand and our capability to listen and respond to our customers' needs. The core customer is behaving as we anticipated. Additionally, we are pleased that since we were introduced to new customers during COVID, we have retained them at higher-than-expected levels. Today, we feel very positive about what we are experiencing across all income brackets and the growth we are seeing. Dollar General is an all-weather brand; we have performed this way for many years and will continue to do so. We will adapt to our customers' needs, as we did this quarter, and are well-positioned to further advance our strategic initiatives, enhancing our appeal to a wide range of customers.
Operator, Operator
We have reached the end of the question-and-answer session. I'd now like to turn the call back over to Jeff Owen for closing comments.
Jeff Owen, CEO
Well, thank you for all the questions and your continued interest in Dollar General. I just wanted to wrap up with 3 points. First, while we had some unanticipated challenges within our supply chain during the quarter, we're confident in the actions we've taken to address these near-term issues and expect continued improvement as we move through Q4 and into next year; second, we believe we are well-positioned to keep growing market share, especially in an environment where customers are even more focused on value; and third, we believe our strong value and convenience proposition combined with our robust portfolio of strategic initiatives sets us up for a very long runway of growth. And we couldn't be more excited about where the future is headed. I want to thank you again for listening, and I hope you have a great day.
Operator, Operator
This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.