The Good and the Bad of Retail Stocks

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

Big retailers such as Wal-Mart (NYSE: WMT) or Costco (NASDAQ: COST) outperformed the S&P 500 during 2012. Will these big retailers continue to rally in 2013? What are the strong and weak points of these companies?

One of the main factors that will keep these companies' stocks rising is if the retail market will keep expanding in 2013. So let's examine the recent developments in the retail market:

Retail Sales Slowly Rising

Based on the latest retail sales report, the total U.S retail sales (in pdf formant) inched up by only 0.1% in January compared to December 2012 and by 4.4% compared to January 2012.  If this modest growth will continue in retail sales, it could suggest the revenues of leading retailers such as Wal-Mart or Costco will rise by at least similar rates.

During last year, Costco's revenues rose by a much sharp pace than Wal-Mart, which could also partly explain why shares of Costco rose during 2012 by a much higher rate than shares of Wal-Mart did. So Costco has an edge over Wal-Mart in revenues growth. Does it also translate to higher profit margins?

Profitability

Despite the higher growth rate of Costco's revenues compared to Wal-Mart's, the latter has a higher operating profitability than the former: during last year, Wal-Mart's operating margin was nearly double at 5.9% compared to Costco's 2.8%. Target (NYSE: TGT), another big retailer, has a profit margin of around 6.4%, which is very close to the operating profitability of Wal-Mart. But Wal-Mart and Costco's profit margin might fall in the coming months because of their decision to expand outside the U.S.   

Going International

One of the main ways that Wal-Mart is increasing its sales is by expanding its operations outside the U.S. I'm not sure if this is the company's best course of action because it includes a rise in risks such as: currency, economies, and political changes, sunk costs (e.g. establishing a branch, legal issues) and local competition (just to name a few factors).

Despite these risks, the international segment is still rising at a faster pace than the U.S segment: during 2013, the company's sales in the U.S rose by 3.9% while Wal-Mart international sales increased by 7.4%. On the other hand, the U.S segment operating profitability is 7.8% while the international segment is only 5%.

Costco is also seeking growth outside the U.S and the international segment is also leading the company's growth in revenues: In the first quarter of FY 2013, the international segment revenues rose by 9%; the U.S segment, by 7%.

So the international segment grows at a faster pace but also leads to lower profit margins and other risks. Therefore, I think these retailers course of action to expand to other countries could eventually cut on their profits and turn them to riskier investments.        

Dividend Payment and Financial Risk

Wal-Mart has recently announced to augment its dividend payment for the fiscal year of 2014 to reach $1.88 per common share – this represents an 18.2% bump compared to the dividend payment in 2013. Based on the current stock price of the company of $70, this means the annual dividend yield will be 2.67%. Furthermore, the company will increase its payout from 32% in FY 2013 to 35% in FY 2014.  This decision is putting Wal-Mart much more attractive than Costco. In comparison, Costco's annual dividend yield is only 1.1%. This company's payout was only 26% in 2013. Target is offering a dividend yield of 2.26%, which is in the middle of the pack among these big retailers. But Target, much like Costco, has a 26% payout. 

The Foolish Bottom Line

The retail industry is growing at a slow rate. Wal-Mart and Costco are expanding their sales by reaching new markets outside the U.S. This course of action might lead to higher revenues but will also make these companies riskier and cut their profit margins. Finally, Wal-Mart's decision to augment its dividend is making this company more attractive than other retailers.

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 Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.


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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