Thursday, May 19, 2005

Wal-Mart, off Target, but aim is improving

Number one Fortune 500 Company in America and the world’s largest retailer, Wal-Mart is huge, and profitable. In the quarter ending April 30, Wal-Mart’s earnings grew 14% to $2.46 billion. These profits are much larger than competitors’ and right in line in terms of growth; rival Target’s profits grew 15% to $494 million in the same period. Despite its mammoth size Wal-Mart’s fiscal efficiency is top in its industry. Wal-Mart’s return on equity, return on assets, and cash flow are better than its competitors. Then why does nobody like the stock? If you bought Wal-Mart stock five years ago you haven’t made any money. Wal-Mart is currently trading around $47, lower than it was in January 2000. Competitors Costco and Target have watched their stocks grow 12.4% and 49.6%, respectively, over the same period. Part of the reason lies in Wal-Mart’s most recent numbers, the latest earnings results missed wall street forecasts by 2 cents. Wal-Mart executives are now warning that they may miss their annual profit forecasts. In addition, the stock wasn’t that cheap five years ago when it traded at near 59 times earnings. However, earnings have grown consistently over the past five years and valuations are more reasonable now. So what exactly is going at the world’s largest retailer that has caused its stock growth to stagnate?
Most obviously, Wal-Mart has been at the receiving end of negative publicity related to union problems. Wal-Mart has managed to keep its workforce union-free and this has spurred many attacks on Wal-Mart of unjust treatment of its employees. There have been allegations that Wal-Mart has employed underage workers to operate dangerous machinery and blatantly discriminates against women by paying them lower wages than their male counterparts. This type of news may make investors wait until issues pass. However, these may not be the most fundamental problems; a look at some other numbers gives us a clue as to what really worries analysts and investors. Same store sales grew 2.9% last quarter, much lower than Target’s 6.2% increase. Wal-Mart claimed that their recent performance was due to bad weather and high fuel prices. Since Wal-Mart shoppers have a lower average income than competitors’ customers, the impact of the high fuel and energy prices may have been more deeply felt by Wal-Mart. This is part of the root of the problem. Wal-Mart’s customer falls in the lower income class with an average annual income of $35,000, approximately $20,000 lower than its largest competitor Target. Traditionally, Wal-Mart has been very successful at focusing on the lower income shopper who has greatly benefited from Wal-Mart’s everyday low prices.
Nevertheless, critics say that Wal-Mart has hit a roadblock with the large population of Americans who are on a very limited budget. Wal-Mart has been expanding its market share rapidly by building Supercenters as close as 4 miles from each other. The basic theory of the expansion holds that once a store reaches $100 million in sales, customers will go to a competitor before they wait in long lines, thus they might as well go to another Wal-Mart store. Critics worry that this strategy produces cannibalization and will not grow sales, Wal-Mart shoppers are tapped out.
Do low income shoppers simply not have anymore money or are there simply not anymore low income shoppers? A little of both, but if it is Wal-Mart’s focus on its core low income consumer that has made it successful in the past, this narrow focus may blind it from opportunities in the future. As a result of their focus, Wal-Mart has been slow to react to new trends in the marketplace. One such trend is to offer more fashionable apparel at low prices to target higher-income shoppers who don’t necessarily seek low prices, but value good quality at affordable prices, the key customer niche for Target. The traditional Wal-Mart shopper goes there for basic household products and groceries and does not venture into the furniture and apparel sections.
There are some recent indications that Wal-Mart has taken notice of Target and the buying power of their customer base. They have been testing products that may appeal to a higher income bracket in an attempt to get these customers into their store. Can Wal-Mart really attract the trendy Target shopper and still keep their low income loyalists? Yes, but it won’t be as simple as a few new upscale products.
The first thing Wal-Mart needs to do is clean up their act. Target shoppers are loyal and loving because they enjoy their shopping experience. Target has a tidy store, nice displays and a speedy checkout. Their shoppers reward them by purchasing a lot more than they intended to when they walked in the door. Wal-Mart shoppers just want to buy and get out. Wal-Mart leaves a lot of money on the table when people don’t enjoy shopping there. People in a higher income bracket simply won’t go there if they don’t like it.
In addition, Wal-Mart has to be deliberate about offering new products at a nicer store, not simply raising prices. This will accomplish two things. First, it will keep shoppers’ confidence that they are still getting the best price on whatever product they are buying, a key reason why people shop at Wal-Mart. Second, there will still be choice for Wal-Mart’s core customers. They will not be unhappy if they can get their typical supplies at their usual prices, all in a nicer store.
Finally, Wal-Mart needs to invest in improving its brand image. It will not be able to attract a new segment of customers by continuing to market themselves as the top low-price retailer. Wal-Mart needs to emphasize that in addition to low prices, they offer the best values, a primary concern of the new customer segment.
Cleaning up its image and bringing in new products will do nothing to hinder what Wal-Mart does well, squeeze enormous value from its distribution and purchasing power and then pass those savings on to its customers. In fact, appealing to this new segment will only help expand the value of their operations to a new set of customers and provide shareholders profit growth from an untapped segment.
The next time you step into Wal-Mart perhaps you will not only find that you get “Always Low Prices” but “Always Best Values, Always”

Lorena Kurtjian
Jason Oberheide
James Quinn

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