The Law of Large Numbers
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In the retail industry there's no question that Wal-Mart (NYSE: WMT) is the clear king of the hill. With the company generating sales of over $100 billion each quarter, Wal-Mart sells more in three months than most retailers do in several years. The biggest challenge that Wal-Mart faces is also something that most people point out as their greatest competitive advantage. The simple fact is, a company selling over $400 billion worth each year simply cannot grow at the same pace of a smaller retailer. That being said, the company's massive size gives Wal-Mart cost advantages that most of their competition can't hope to match. Looking at the company's earnings report, we see the challenges that the company faces trying to grow at a significant rate.
In the most recent quarter, sales at Wal-Mart were up 4.5% and the company increased diluted EPS by 8.3%. What was particularly interesting to note, was many international companies have blamed weakness overseas on their lower results while Wal-Mart performed quite well. For all of the company's stores overseas, Wal-Mart is still mainly a domestic retailer. The United States division represents 59% of total revenues, and showed sales up 3.8%. U.S. based comparable sales increased 2.2%, and income for this division rose 5.3%.
The company's international division represents about 28% of total revenues. With this unit showing both comparable sales and total sales up 6.4%, international income increased 5.4%. As Wal-Mart continues its international push, the company's growth rate should pick up slightly as international sales are growing faster than domestic. The seemingly forgotten portion of Wal-Mart's business is Sam's Club. This division represents just 12% of total revenues, but turned in fairly impressive results with sales up 3.8% and comparable sales increasing 4.2%. What was most impressive, was the company's ability to turn single-digit sales increases into just over a 10% increase in income. While these results are certainly nothing to be ashamed of, the most impressive part of the company's most recent earnings is found in their financial statements.
Wal-Mart's operating cash flow over the first six months of this year increased 19.44%. Equally impressive was the company decreased its share count by 2.5%, while cutting long-term debt by $4 billion. This was all made possible by over $6 billion in free cash flow. Wal-Mart paid out about $2.7 billion in dividends, which gives the company a 44.43% free cash flow payout ratio. The remainder allowed the company to cut its debt, and also shows Wal-Mart should be able to continue its dividend increases into the future. The question for most investors is because of the company size and competitive pressures, what's next for Wal-Mart?
Walmart's competition is both well known and well financed. Companies such as Target (NYSE: TGT), Amazon.com (NASDAQ: AMZN), and Costco (NASDAQ: COST), have some of the same competitive advantages that Wal-Mart offers. Each of these companies seem to have developed a distinct niche in their sales strategy. While many people compare Target and Wal-Mart, the two stores seem to have different focuses. On the one hand, Target is more well-known for their fashion and home goods, and most stores leave the main aisles completely clear for customers. Wal-Mart is primarily focused on taking over grocery sales, and in an effort to squeeze as much selling space as possible out of every store, will routinely place displays in the middle of the main walkways.
By contrast, Costco is one of the most well known warehouse stores in the country. While members have to pay an annual fee to belong to the warehouse club, the company operates with razor thin margins and offers products in larger sizes, than a traditional Walmart or Target store would. While Amazon has been touted as the future of retail, the company's focus seems to be on digital distribution and fast delivery times. One thing that is changing about Amazon is, the company is becoming more of a physical retailer through their continued growth in distribution centers, and the company expects this to continue.
Of the four companies, I personally favor Target above the rest. At this point, Amazon is simply too rich for my blood. The company needs to show that they can produce the huge profits that investors seem to expect. Costco's margins are so slim that the company literally makes about half as much on each dollar of sales as the rest of their competition. This leaves Wal-Mart and Target, and at the current time Target has the higher yield, higher growth expectations, higher gross margin, and lower P/E ratio. With all these clear advantages, I don't see a reason to choose Wal-Mart over Target at today's prices. Walmart's large-size gives the company some advantages, but ultimately the law of large numbers hurts the company's chance of significant growth going forward.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Costco Wholesale. Motley Fool newsletter services recommend Amazon.com and 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.