The Big Box Retailer Risk

By Shawn Robinson - January 3, 2012 | Tickers: ATVI, BBY, GME, MJN, NTGR, SHLD, WMT, WHR | 0 Comments

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Sears Holdings (NASDAQ: SHLD) announced last week that they plan to close over 100 Sears and Kmart stores to trim costs due to poor holiday sales. That news sent shares of the retailer down around 25% as investors fear that Sears will continue to have trouble operating in this competitive environment.

Investors also reacted to the news by sending shares of Whirlpool (NYSE: WHR) down almost 9%. Why? Because according to WHR’s most recent 10-k, the company generates about 8% of sales from Sears stores. Considering Whirlpool also sells products in Home Depot and Lowe’s, any loss in sales at Sears wouldn’t be catastrophic, but does cloud the appliance makers prospects for 2012. Even though it appears WHR would survive if Sears continues to have trouble, the reaction inflicted on the WHR shareholders highlights the importance for investors to understand and appreciate the big customer investment risk. Just as investment professionals stress the importance of diversification in personal portfolios, investors should consider the amount of diversification risk or significant exposure that the companies they invest in have to individual customers.

There are two main reasons why having one or two customers be a large part of their overall sales can be problematic:

1. The customer could leverage position for pricing power

Wal-Mart (NYSE: WMT) is not surprisingly the number one destination for any company wishing to sell goods to consumers. The Arkansas behemoth sold $420 billion in goods in 2010 alone. Most executives probably aren’t too concerned about the amount of their sales that go to the house Sam Walton built as, what are they going to do, not sell to them? But companies and therefore, investors, should understand the consequences of relying on big box retailers like WMT as at any given moment their whims could change. Give for example the recent announcement by Wal-Mart of pulling Meade Johnson’s (NYSE: MJN) Enfamil baby formula from their 3000 store shelves after a reported infant death. The reaction sent MNJ’s shares down almost 10%. Even though pulling the formula was the right move, it shows that the actions of the company could have troublesome consequences for suppliers that sell to them. What if WMT wanted to start squeezing the pricing of their suppliers by purchasing from competitors or demanding lower prices? What if they started demanding more incremental operational costs to do business? The more market power the customer has over a supplier the more negative it could become for investors. Declining margins are hardly ever a joyous experience.

Here is a table of a few companies with higher than normal sales reliance on Wal-Mart as reported in their most recent 10-k.

Latest Fiscal Year
Percentage of gross sales at Wal-Mart

2. The future for the customer is cloudy

The previously mentioned Whirlpool/Sears relationship is an example of this risk. When a customer begins to show signs of weakness, all those who do business with them suffer as clarity around the future of the business becomes questionable. Growth prospects become hard to estimate, receivable default risk comes into play, and the uncertainty makes investors cringe. Sometimes the customer goes into the worst case scenario of bankruptcy or other times the customer chugs along like a zombie.

Some additional worthy examples for this risk is Netgear (NASDAQ: NTGR) and their 15% reliance on Best Buy (NYSE: BBY) or Activision (NASDAQ: ATVI) and their 12% reliance on GameStop (NYSE: GME). Both retailers are probably not going bankrupt any time soon but growth is estimated to be difficult to come by.

What are some other risks? Do you know of any stocks that rely heavily on one or a few customers? Share them in the comments below!

Fool on!

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