By A. Mirhaydari
Video
After a long winter, spring is in bloom. So is the economy. People are going back to work. Wallets are opening again. Dollars are zipping from hand to hand like honeybees pollinating an orchard.
And the fight for many of those dollars is shaping up as another round in the epic battle between two retail giants: Wal-Mart Stores (WMT, news, msgs) and Target (TGT, news, msgs).
The 'new frugality' lives on
To some, their tale is the story of the recession -- which, it's fair to say, Wal-Mart won. Early in the downturn, as consumers switched to discounters for inexpensive food and cheaper goods, Wal-Mart's stock rose more than 50%. As more upmarket stores took a hit, Target's stock lost more than 60%.
But we're at a turning point. Fearful that consumers will move back upscale, Wal-Mart is focusing on spiffing up its stores while maintaining a price advantage over Target. Meanwhile, Target is touting more-fashionable offerings by telling customers to "expect more, pay less."
Investors are clearly betting on Target. Since March 2009, when the market rebound began, Wal-Mart has been trading sideways. Target's stock has risen 138% in 13 months.
At the turn
But has the market picked the right horse? So far, it would seem so. In the fourth quarter of 2009, for the first time since the recession began, Target enjoyed better sales and customer traffic numbers than Wal-Mart did.
Target saw a 2% boost to customer traffic during the fourth quarter, while Wal-Mart suffered a slight decrease. Same-store sales also fell 1.6% for Wal-Mart's U.S. business; Target saw a 0.6% increase.
Wal-Mart Show of Weakness?
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These numbers have fed the notion that consumers who traded down are trading back up. Target seems to have momentum: Management recently increased first-quarter earnings projections based on strong sales.
We'll find out more when Target reports quarterly results Thursday; Wal-Mart reports Tuesday.
That notion explains why Wal-Mart has basically been left out of a historic market move. From the March 2009 low to the mid-April high, the Standard & Poor's 500 Index ($INX) has shown the largest and fastest gain -- up 79% in 13 months -- of any new bull market rally in the past 50 years. Yet Wal-Mart shares have trended lower, in a pattern reminiscent of the sideways grind that characterized the stock during the go-go market years from 2003 to 2007.
Wal-Mart, which is America's largest retailer, with 4,300 U.S. stores, seems to recognize the problem. A zealous focus on cut-rate prices doesn't work as well when shoppers are feeling flush. Target, No. 5 in sales and with 1,740 stores, has a different attitude. It drives visits through product selection and a more attractive shopping experience, from shorter checkout lines to nicer restrooms.
Click graphics to see interactive charts
Wal-Mart Stores
Target
Both companies have launched initiatives to drive growth as the economy improves. But can Wal-Mart adapt? And will Target keep going, with the help of projects like a fresh grocery initiative that challenges Wal-Mart's bread-and-butter food business?
First, of course, they need to be sure the retail rebound really has legs.
Is the retail recovery for real?
The economic data sure support the idea that a consumption renaissance is under way despite all those predictions of consumer frugality being here to stay.
Retail sales grew 0.4% in April after a 2.1% surge in March -- which had been the best monthly performance since January 2006. The April sales numbers were up 8.8% over last year. The two-month average for chain-store sales is up 6.3% from the recession low and is now almost back to the 2007 peak. Wage growth is also on the rise for the first time since 2008. And on May 7, we learned that the economy had created 290,000 in April, the best performance since March 2006.
There is plenty of anecdotal evidence, too. Apple (AAPL, news, msgs) sold a million iPads in just 28 days. Domino's Pizza (DPZ, news, msgs) posted a huge 14% jump in sales in the first quarter, which ranks as one of the largest-ever quarterly same-store jumps recorded by a fast-food chain. And the new "Iron Man 2" movie sold $134 million in tickets in its first weekend, ranking it as Hollywood's fifth-biggest opening ever.
Overall, nominal consumer spending in the first quarter has already passed its 2008 peak, and it is now on track to move further into new territory.
Sure, the data aren't universally strong. Initial weekly jobless claims remain troublingly high with about 450,000 people filing for new unemployment benefits each week. The housing market could weaken with the May 1 expiration of the homebuyer tax credit. The number of food stamp recipients continues to move to new highs. And the ISI Group's surveys of retailers have started to show a weakening in sentiment over the past four weeks.The ISI Group's sales surveys of credit card companies, shopping guide companies, furniture stores and auto dealers are all moving higher. And consumer stocks, as represented by the Consumer Discretionary Select Sector SPDR (XLY, news, msgs), an exchange-traded fund, and including stocks such as Target and Ford Motor (F, news, msgs), have been one of the market's best-performing sectors this year. XLY is up 11.1%, compared with a 1.9% rise for the S&P 500. And that ISI Group retail sales survey had previously made an explosive jump to new highs.
Besides job growth and wage expansion, which we're now starting to see, the level of consumer indebtedness is the next-most-important driver of consumer spending. Things are looking good on that front, too: The household debt service ratio, which compares interest and principal payments to disposable income, fell to 12.6% as of the fourth quarter -- the lowest since 2000.
Combined, the evidence suggests that the consumer bounce-back is for real.
Wal-Mart fights for its edge
As cautious consumers used to paying more elsewhere flocked to Wal-Mart during the economic downturn, the store didn't have to offer as many price markdowns. Higher prices meant bigger margins, which drove profits.
But the company's price advantage over some competitors, such as grocery stores, began to narrow.
This set up the company for trouble in the recovery. Consumers decided that the savings Wal-Mart offered over the likes of Kroger (KR, news, msgs) and Safeway (SWY, news, msgs) weren't worth the hassle of shopping for groceries in a big-box store.
Citigroup analyst Deborah Weinswig found that the price gap between Wal-Mart and Kroger fell from 27% in August 2008 to 22% in December 2009. Weinswig believes this was a big reason Wal-Mart posted its first decline in same-store traffic in the fourth quarter in two years. In the fourth quarter, Wal-Mart's U.S. same-store sales dropped 2% from a year ago as traffic declined.
Wal-Mart's management responded. It refocused on price rollbacks, making bigger price cuts and increasing spending on marketing to advertise them. We can already see the effect this effort has had. A recent pricing survey from Credit Suisse analyst Michael Exstein found that the price gap between the two has widened noticeably to levels not seen since early 2009.
But price isn't all that's bothering Wal-Mart. Things such as merchandise breadth and depth, store appearance, checkout speed and merchandize quality have also been hampering growth. Apparel sales, for instance, dropped 8% in 2009. Though nearly 60% of Target's merchandise mix is discretionary, a full 49% of Wal-Mart's revenue comes from groceries.
That means Wal-Mart has less to offer customers besides the basics.
This is changing, too. Wal-Mart recently moved its apparel headquarters to New York and is staffing the satellite office with talent from department stores and specialty apparel chains. (The regular headquarters in Arkansas isn't exactly at the center of the fashion universe.)
The company also continues to roll out its "Project Impact" store makeovers. Dour gray carpet and white linoleum are being replaced with bright blues, faux wood flooring and more-open floor plans. By the end of the year, 32% of Wal-Mart's stores will have received the facelift, and all stores are expected to be remodeled by 2014.
The company is also focusing on initiatives dubbed "Clean Action Alley" and "Smart Network." The first refers to keeping the main aisle on the food side of the store clear of merchandise pallets, replaced by end-cap displays; the second involves the placement of television displays with product information. Combining these two initiatives has increased items in baskets and resulted in higher ticket prices.
These aren't small changes. But investors are obviously skeptical, especially with Target now hitting its stride.
Target enters the sweet spot
While Wal-Mart's focus remains low-price leadership, Target has begun touting the "expect more" half of its low-cost, high-quality personality. It recently took out a full-page ad in The New York Times encouraging shoppers to "expect more than just a low price" and railing against sale or price gimmicks. This brought an end to 18 months of focusing mainly on price.
The timing is perfect. The company is reaching upscale with product launches from fashion designers such as Jean Paul Gaultier and Zac Posen. Recently, the company has seen strength in its apparel sales categories.
Still, there are some concerns here, too.
The company is in the midst of a rollout for its new "PFresh" fresh grocery concept that is now in 350 locations, 20% of Target's store base. The idea here is that by offering more refrigerated goods, Target's general stores can act as a fill-in for trips to the grocery store. The hope is that customers dropping in for dinner items will visit electronics, apparel or toys.
Early results have been lukewarm: Jefferies analyst Daniel Binder notes that the increased traffic benefit from PFresh hasn't resulted in "meaningful cross-shopping to the general merchandise side of the store." But Binder is confident that it's "just a matter of time before this happens and could provide upside to the story."
So which stock to buy?
Though both companies carry significant implementation risk as they roll out significant store remodels, Target continues to enjoy a natural advantage in this economy. This is especially true as the company leverages its lead in the apparel space. Binder is looking for Target to earn $3.81 per share next year and $4.30 in 2012 as the economic recovery rolls on.
Despite its run-up, the stock is currently selling for 13.1 times Binder's 2012 earnings-per-share estimate, well under the company's five-year average price-to-earnings multiple of 15.5. That's a common way to tell if a stock is overpriced, and it suggests this one isn't. Running the numbers gives you a price target of $66.65 a share -- an 18.3% gain from here.
If you don't want to worry about earnings and price multiples, take a look at the relative strength of Target's stock compared with Wal-Mart's. As you can see in the chart above, the 50-week moving average of this ratio does a nice job of predicting the economic cycle and the relative performance of the two companies.
The breakdown in late 2007 came a couple of months before the recession started, while the April 2009 upswing happened a few months before the economy started growing again. (You can find an explanation of relative-strength stock charting here.)
The same thing happened in 2003, with the Target-to-Wal-Mart stock price ratio moving over the 50-week average in May and not looking back until 2007 except for a brief hiccup in 2006. During the period, Target consistently outperformed Wal-Mart except for that hiccup. If you bought Target instead of Wal-Mart when the relative strength ratio first went over the 50-day average in early 2003, you would've enjoyed a performance differential of 112% (TGT returned 87.5%, while WMT lost 11.4%).
I expect a repeat performance in the years to come. Target does better in better times, which is why it's the stock to buy now.
Eventually, when the economy begins to slow again, Wal-Mart will come back. By then, it will have remodeled all its stores and improved its product mix. Perhaps the next time, Wal-Mart will impress all those trade-down customers enough to keep them. I think the company missed its chance this time around. MSN.com
I would buy Target & Walmart for the long term ....
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