A Tale of Two Retailers

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It was the best of times; it was the worst of times. For the worst of times many investors consider big chain stores as a solid investment as they provide reasonable dividend and steady growth in both stock and revenues. Let's examine big retailer chain stores such as Wal-Mart Stores (NYSE: WMT) and Costco Wholesale Corporation (NASDAQ: COST). These big chain stores have some similarities, but also differ from one another in other aspects for investment purposes. Let's analyze the retail market development and the different big retailers. Are these investments worth considering if you believe we are headed for the worst of times? 

During the year, shares of Wal-Mart have done slightly better than the S&P500 index: Wal-Mart rose by nearly 14.2% while the S&P500 index increased by 11.7%. In comparison, other big retailers such as Costco rose by 18.5%; Target Corporation (NYSE: TGT) increased by 15.5%. This shows that all of the above-mentioned retail chain-stores have slightly out-performed the market.

The higher growth of Costco's stock also coincides with the company's higher revenues growth than these other giant retail chain stores.

The chart below shows the annual growth in revenues of all three companies in recent years. As seen, the revenues growth of Costco is much higher than that of Target or Wal-Mart.   

(*For both Target and Wal-Mart the year ends on January; for Costco at the end of the August; **for all three companies 2012 revenues were up to October/November 2012) 

Let's turn to the industry and examine how retail sales in the U.S have developed in 2012.

Sales Slowly Rising

According to the recent retail sales report, the total retail sales (in pdf formant) in the U.S rose by only 0.3% in November, and in the first eleven months of 2012 total retail sales increased by 5.5%. This slow growth in sales coincides with the growth of the U.S economy: the GDP for the third quarter expanded by 3.1% (in annual terms). Moreover, Wal-Mart Stores has also showed similar growth in its revenues. During the third quarter the company's revenues expanded by 3.4% compared to the same quarter in 2011. This finding suggests, at face value, the growth of Wal-Mart's revenues is driven mostly by the growth in the U.S economy and less by the business development of the company.

On the other hand, revenues of Costco and Target increased by a much sharper rate in the third quarter: sales of Costco increased by 17.7% compared to 2011; Target's revenues grew by 13.4% compared to the previous year. These figures suggest that these companies growth was not limited to the growth of the economy and was also driven by these companies business development.  

So the industry is only slowly progressing. What is the profitability of these retailers?

Wal-Mart's operating profitability is very similar to other leading retail chain stores such as Costco and Target. The table below shows the operating profitability of Wal-Mart, Costco and Target on a quarterly basis in 2011 and 2012.

As seen, the operating profitability of the Wal-Mart and Target remained stable between 5% and 7%; the profit margin of Costco remained unchanged at 3% in recent quarters. These low and stable profit margins are reasonable for the highly competitive retail market. 

Financial Risk and Uncertainty

Wal-Mart's financial risk is in the middle of the pack compared to its competitors. The chart below shows the debt-to-equity ratio for Wal-Mart, Costco and Target as of the recent quarter of 2012. As seen, the debt-to -equity ratio of Wal-Mart is much higher than that of Costco but lower than Target's. This measurement suggests that Wal-Mart is taking more financial risk than Costco – this could make the former a bit riskier than the latter.

Besides the financial risk, big retail chain-stores such as Wal-Mart also experience uncertainty around the currencies fluctuations that affect the company's revenues. In the third quarter, currency shifts pulled down revenues by nearly $1.7 billion or nearly 1.5% of the total revenues in the quarter. These unfavorable currency changes might continue adversely affecting the company's revenues in 2013.

The recent labor dispute that was on the news for Wal-Mart workers is another consideration that could pose an additional uncertainty that could pull down the company's valuation in the long term.

Dividends

In regards to dividend, Wal-Mart is offering a higher annual yield than Costco: Wal-Mart's annul dividend yield is nearly 2.3%; Costco's yield reaches only 1.07%. Target is closer to Wal-Mart with an annual yield of 2.4%.

The Foolish Bottom Line

The retail industry is slowly progressing along with the U.S economy. In a micro view, each of the big retail chain stores has different relative advantage: Costco is presenting a sharp rise in revenues along with a relatively low financial risk; Wal-Mart has a higher profit margin, is much bigger and offers a higher dividend yield. In any case, if you believe the markets aren't going to improve in the near future, these investments or a combination of them might be worth considering.    

For further Reading:

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QE3 Is Here, So Why Isn’t Gold Pulling Up?

 


liorc has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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