Summary
Goldman Sachs may be right with respect Walmart, for all the wrong reasons. Here's more.
Analysis
Any discussion of Walmart invokes cacophony among investors and analysts alike. Since the company went public one side has steadfastly argued that Walmart would eventually obliterate traditional retailing as, like a giant vacuum cleaner, it would eliminate smaller competitors by broadening its low price offer to more categories of merchandise. Others disagreed, but acknowledged its supremacy as a nation’s low price leader pushing it to the top of the heap of transient discounters that have permeated retailing since the 1950’s, but no more than that.
For much of the last decade, investors watched as Walmart’s domestic sales and earnings stagnated. Then for believers, international growth would have to do for the company what its pernicious, domestic retail strategies had failed to accomplish, that is, restore Walmart to its earlier position as a fast-track, high growth retailer with equivalent multiples. That is, until the US financial system nearly collapsed and the economy tanked.
Now, as consumers wander in the endless muck the first “depression-recession” since the 1930’s, Walmart’s efficacy is in question again. Goldman Sachs’ analysts think a second half recovery would shift the consumer’s increased discretionary purchases away from Walmart to more traditional retailers. The operative words here are “recovery” and “increased discretionary spending”’ neither of which are a certainty.
In fact, most big retailers don’t anticipate any recovery in the second half, at least if their merchandise orders speak louder than the media spin about an improving economy reported daily in the press. According to reports, overseas orders for delivery six to nine months out are about 20% less than last year, meaning sales will be down if for no other reason than stores won’t have the stock to support increased demand, if it materializes and that’s a big if.
In addition, there’s plenty of other evidence that big retailers are right and media hints of a second half recovery are fatuous. For instance, while sales declines appear to have bottomed out, net job creation is still negative and unemployment claims persist. Moreover, consumers are now calendarising last year's economic stimulus rebate that pumped between $600 and $1,200 in cash into most US households. There’s no match off to that stimulus this year and just how much of that will be offset by the 2009 trillion dollar stimulus bill still remains uncertain.
Then, there’s the negative impact of the GM and Chrysler’s bankruptcy on sales growth regionally as well as on consumer buying behavior nationally. Last year, car sales and auto industry employment were significantly higher, which enabled more discretionary spending relative to today. Currently, auto sales are about 50% less than last year and industry-wide unemployment is escalating as thousands of dealerships close, older factories shuttered, and redundant brands sold off.
Lastly, the DJI is still more than 25% below last year’s average. It’s also about the same as it was during December 2008, which suggests consumers that stayed in the market haven’t recouped their lost wealth. For others, much of their remaining liquidity, if any, is in US Treasury instruments that the Fed is using to finance part of the country’s burgeoning debt for “social reconstruction”. Add the savings rate is higher now than in the last 20 years, which could reduce retail sales by about $1 trillion annual, and a second half recovery not only seems remote this year, but in 2010 also.
Realistically, all evidence points to the conclusion consumers are a lot less wealthy today. That’s in contrast to last year when they feared they would lose some of their wealth, but didn’t know how much. Now, those fears have been replaced by the rugged reality that their 401k, other savings, home equity, and credit lines have permanently diminished for the time being. If true, increased discretionary spending seems equally remote in the second half, whether at traditional retailers or Walmart.
Still, it’s hard to make a case for Walmart picking up a lot more market share year over year in this economy, not because of a recovery, but because of the lack of one. That’s especially true in the rural areas where they are so dominate. The retailer has had a virtual monopoly in these markets for years. So, consumers aren’t trading down “to” Walmart as much as they are trading down “ in” Walmart. That has to decrease sales, which can only be offset by higher prices, something the company has tried to do before, but with limited success. More and more, astute observers have watched Walmart raise prices only to lower them as sales declined even further.
Urban areas are a different matter. More consumers will make the switch to Walmart as the effects of the recession broaden and impacts their job and earning capacity. That’s a real growth advantage for the company. Yet, Walmart’s reliance on entry-level product and secondary brands limits their appeal in these larger markets where price and brand competition is much greater. Unfortunately, the company never established a viable house brand in hard goods and soft lines that they did for consumables. The equivalent of the “Great Value” brand for electronics, apparel, household products…etc., could have had the effect of a category killer for the company, especial in this economy.
In that regard, according to reports, the company plans to relaunch its “Great Value” brand within the next 30 days. The relaunch is expected to include more products, but it’s doubtful, Walmart will extend the brand beyond its current category range. Investors will have to wait and see. What may be of more significance is how Walmart customers respond to higher “Great Value” prices. While new “Great Value” products will offer shoppers a low price alternative to existing national brand items, Walmart usually increases the price of many of its existing house brand items at the same time. Individual item price increases can be quite substantial. For instance, increasing a price on an item from $0.50 to $0.68 or about 36% isn’t uncommon. The question is, without the media’s certain recovery, will customers buy enough units to increase gross profit at the new price?
Clearly, the fourth quarter will bring with it retailers that will out perform their peers. Walmart maybe one of them, so will other large chains. However, it is problematic whether Goldman Sachs’ view of retail sales will adequately describe how year end sales performance will evolve for large retailers.
