Is the Wal-Mart Model in Trouble?
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Wal-Mart (NYSE: WMT) has become an icon of American society. The company relies on the international market to source cheap products and sells them in centralized distribution centers in suburbia. Rising energy costs will hurt Wal-Mart's consumers and increase the cost to transport goods to market. These risks are long term liabilities that will impact Wal-Mart's future.
The Energy Situation
It shouldn't be surprising that energy costs are rising much faster than the core inflation rate. This poses a major problem for retailers that focus on the lower end of the market. Wage growth over the past three decades has not been strong in the U.S. Financial crises and off-shoring have hurt job growth. America has a relatively low population density, and this means that workers need to travel long distances to reach work and go to the grocery store.
The future is not looking much brighter. America has experienced a major energy boom with new technology like fracking opening up new supplies. This does not necessarily translate into lower prices at the pump. Lack of transportation capacity has caused some companies to cut back. Suncor, an oil sands firm, recently decided to reevaluate an expansion at one of their facilities due to lack of pipeline capacity. Canada is considering exporting their oil to Asia instead of the U.S. in order to benefit from higher prices.
US Core Inflation Rate data by YCharts
Wal-Mart's Financials
With a total debt to equity ratio of 0.78 the company is not constrained by debt. Interest rates are at very low levels and well-respected companies like Wal-Mart can easily get low-cost finance in the bond market. Even with a return on investment of 14.9%, rising energy costs are not a simple problem that can be dealt with the touch of a button. Wal-Mart trades at a P/E ratio of 14.5. With the long term risks posed by increasing energy costs, I believe it should be trading at lower levels.
What about the Competition?
Dollar Tree Stores (NASDAQ: DLTR) and Dollar General (NYSE: DG) serve similar markets. Still, these companies have added their own spin on Wal-Mart's strategy. Instead of giant stores in suburbia they build smaller stores that are closer to their customer base. Many low income consumers do not have cars and are forced to use public transit. By using smaller stores, these companies can fit into smaller lots in urban areas. Increasing energy costs will still affect their consumers' wallets, but these firms are better positioned to deal with the effects.
Dollar Tree has little debt, with a total debt to equity ratio of 0.17. The firm has been growing quickly and used share buybacks to reward investors. Dollar Tree's return on investments of 32.3% and profit margin of 8.2% show that the company has created a very profitable operation. Wal-Mart is many times Dollar Tree's size, but its ROI and profit margin are much lower.
Dollar General is very similar to Dollar Tree, but its numbers are not as encouraging. Dollar General has a return on investment of 12.0%. Wal-Mart and Dollar Tree both have a more effective use of investments. Dollar General's profit margin of 5.8% places it between Wal-Mart and Dollar Tree. On a valuation basis Dollar General and Dollar Tree trade are almost equal with a P/E ratio around 16.75. Dollar Tree's stronger return on investment makes it the better investment.
Conclusion
Energy constraints will affect the global economy for decades. The low energy prices of the last century are gone and companies will have to change accordingly. Dollar General and Dollar Tree appear better situated to deal with increases in energy prices. Dollar Tree has little debt, strong profit margin, and is a good investment to consider.
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