What Should This 800lb Gorilla Do?

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

Many companies are concerned with battling the leader in the industry. Small businesses have to come up with creative ways to make sure they offer a different product or service from the market leader. What if instead of being the small company fighting the big company, you are that 800lb gorilla in your marketplace? This is the situation Wal-Mart (NYSE: WMT) faces today. It is the market leader when it comes to retail sales, but what can the company do to continue growing and competing?

Wal-Mart Has Its Competition Beat By These 2 Measures

If you ask the average person for the names of Wal-Mart’s major competitors, you’ll likely hear companies like, Target (NYSE: TGT), Costco (NASDAQ: COST), and Amazon (NASDAQ: AMZN). Target and Wal-Mart go head-to-head in many towns in the U.S. and now that Target is taking its show to Canada, this battle may become global.

Costco offers groceries and other items at cheap prices but charges a membership fee like Wal-Mart’s Sam’s Club. Everyone knows that Amazon is a threat to any industry they enter. With general merchandise sales making up 64% of Amazon’s total revenue, the company has set its eyes on Wal-Mart’s throne.

All this being said, one thing Wal-Mart offers that beats their peers is a class-leading yield. The company’s dividend of 2.4% trumps Target at about 2% and Costco at 1.1%, and of course Amazon pays no dividend at all.

Another positive is the value of the stock relative to what investors can expect in total returns. We already know Wal-Mart’s yield of 2.4% leads their peers, and though their expected growth rate of 9.29% is lower than their peers, their P/E ratio of about 14.5 is lower as well. In fact, if we use a PEG+Y calculation to compare these companies, Wal-Mart looks like the second best value of the bunch.

The PEG+Y ratio compares a company’s yield and expected growth to their projected P/E ratio. The higher the number the better, and Wal-Mart scores a 0.80. By comparison, Target sells for almost the same P/E ratio, but has a higher expected growth rate, which gives the company a PEG+Y of 0.87. Costco seems expensive considering its lower yield and only slightly higher growth rate, and it scores a 0.60. Amazon’s stratospheric P/E ratio dwarfs the company’s expected growth and gives the stock a PEG+Y of just 0.19.

Under Pressure
It’s one thing to like Wal-Mart’s yield and value, it’s another thing for a company with over $400 billion in annual sales to continue producing good results. One of the biggest opportunities for Wal-Mart is unfortunately hurting the company’s margins.

Wal-Mart is trying to take market share in the grocery business, and for the last two quarters the company reports they are succeeding. This industry is worth billions and can support many large players. The problem is, Wal-Mart’s gross margin is being compressed because of these sales.

In the most recent quarter, Wal-Mart’s gross margin was 24.66%. While this is better than Costco’s gross margin of just 12.64%, it falls behind Amazon at 26.56% and lags Target’s margin of 30.70%. However, Wal-Mart’s over 4,000 domestic locations, and the fact that they always have low prices, make the company a tough competitor in this space.

It’s Not Enough
There is just one huge problem with trying to take market share in the grocery business. As Wal-Mart steals market share, their margins theoretically fall. If this trend continues, the company’s sales will appear weak until their margins stabilize.

With domestic sales increasing just 0.3% and international sales up just 2.9%, the company’s revenue growth leaves something to be desired. What Wal-Mart needs to do is borrow heavily from their competitors’ business ideas. First, Wal-Mart needs to scale back the size of their CD, DVD, and Blu-ray selling space. To be blunt, the move toward digital entertainment is killing the value of these physical formats, and other retailers like Best Buy are suffering because of this transition too. Best Buy is beginning to move floor space toward better selling items, and Wal-Mart needs to make this choice as well.

Second, Wal-Mart needs to put more focus on its online sales. Target’s Redcard offers shoppers free shipping and a 5% discount. Costco’s warehouse pricing can beat Wal-Mart at its own game, and Costco’s partnerships offer members discounts on everything from brokerage accounts to auto purchases. Amazon is getting smarter by asking about purchases, sending e-mails to suggest items from categories customers have already looked at, and making suggestions. Wal-Mart offers a decent online selection, but that’s about it.

Last but not least, Wal-Mart needs focus on parts of their store that can offset the pressure of increased grocery sales. The company’s aisles are often crowded and sometimes disorganized. Wal-Mart has increased their clothing and home goods options, but they need to look to Target’s example and get a known designer to offer items exclusive to their stores. Higher margin clothing or home goods are how Target maintains a better margin despite the fact that over 75% of Target stores offer groceries.

Wal-Mart is a great company with huge sales and bargaining power, the company just needs to experiment with a few changes to regain their seemingly lost sales momentum. The stock offers a good value already, but imagine what it would be worth if the company returned to double-digit earnings growth. Wal-Mart must adapt and change with the times, or this 800lb gorilla will be looking up at another company sitting on its throne.


Chad Henage owns shares of Target. The Motley Fool recommends Amazon.com and Costco Wholesale. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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