Why to Play it Safe when Selling to U.S. Consumers
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Everyone knows that the U.S. consumer is under a great amount of pressure. With sluggish housing prices an unemployment rate still above 8% there are many negative forces in the U.S. economy. An important part of investing is looking at what is known and what is speculation. Taking fact as theory or theory as fact is dangerous and a very easy way to destroy one's ability to correctly understand a situation. Although nominal U.S. GDP continues to grow the U.S. economy is not growing in a uniform fashion. The average U.S. worker is still under great pressure and as such has oriented their cash flow to savings and necessities. As the below chart shows the number of people unemployed for 27 weeks and over is still at a very high level. The high growth environment of the past decades may never return. Even with interest rates at record lows the U.S. consumer is working hard to recover from the balance sheet damage done during the housing crisis. As shown in the second graph the growth in total consumer credit owned and secularized has just past the inflation rate and is not where near the growth levels seen during the 80s or the 90s. Investing in large dependable companies like Wal-Mart (NYSE: WMT) may sound like a "recession only" strategy but such a strategy is still relevant today.
In a modern society consumer where almost all transactions are monetized the extension of credit is crucial for the growth in the economy. People do not bring pigs and iron to barter for apple and frozen pizzas. Credit cards, cash, and lines of credit are used to purchase their goods. Attaining credit allows a purchase to occur. Looking at the amount of consumer credit gives a good idea of the future direction of the economy. The below chart shows that U.S. consumer credit is still growing at a snails pace. From 2005 until now consumer credit has been at or near the change in the total CPI rate. Without a substantial increase in credit the majority of people won't beable to buy a new boat or a bigger house.
Wal-Mart is one of the world's largest companies and its logistical and management abilities allow it to maintain its' dominance. U.S. sales growth has not been constant over the past years. As the 2008 recession ended some of their consumers returned to shopping at higher end companies. Even in these years of negative U.S. growth their international operations allowed them to post growth in total net sales. The total debt to equity ratio of .79 is considerably less than that of Target (NYSE: TGT)'s 1.16. Target is more focused on the United States though their purchase of Zellers in Canada will provide them with some international exposure in the coming years. Their revenue and EPS growth is weaker than Walmart's. Target's margins are higher than Walmarts which gives more room to deal with future inflation. With their main compeitor holding the dominant position Target does appear to be more risky. Costco (NASDAQ: COST) has shown strong revenue growth and earnings growth over the past couple years. They have a strong international division though the U.S. division has still shown growth over the past 5 years at an average of 4% per year. Its' five year EPS growth is only 7.61% while Walmart's is 9.39%. Two other great ways to play the weakness of the U.S. consumer to look at Dollar General (NYSE: DG) or Dollar Tree (NASDAQ: DLTR). Both of these stores have seen revenue grow at about 10% per year over the past three years. The bigger gross margin and EBIT margin at 38% and 12% respectively make the Dollar Tree the better looking company. The Dollar General has total debt to equity ratio of .63 which is more than three times as high as the Dollar Tree's .17. Given higher unemployment rates and lower wages for the less skilled these discount chains really do hit a resounding chord with a large percentage of the American consumer.
The U.S. economy is still recovering from the 2008 recession and consumers are still constrained. By investing in large grocers and dollar stores investors can keep their funds where the consumer is. Grocers and dollar stores are safe place until consumer credit shows serious real growth and it is obvious that consumers can and will increase their spending. Investors live in a world of unknowns but investments start with that which is known.
MrCanadian1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.