In an appearance on NBC’s “Meet the Press” on Sunday,
Wal-Mart Stores Inc. (NYSE: WMT) Chief Executive Officer H. Lee Scott Jr. said the recession is changing consumer-buying habits.
What Scott didn’t say is that Wal-Mart is perfectly positioned to capitalize on those changes.
“The No.1 issue today is [consumers'] concern about their job," Scott said during the nationally televised interview. And because of that concern, Scott said consumers are making some of the following changes:
- In the discounter’s “pharmacy group, we have increases in prescription drugs, but not at the same rate it was. What we're seeing is an increase in self-treatment."
- Cash-strapped shoppers also are making different food choices, meaning Wal-Mart is “seeing an increase in food storage as people are cooking more at home.” Consumers are "using leftovers more extensively," and buying more frozen food.
- Even the owners of small businesses are altering their buying patterns to better manage their cash flow, by shopping more frequently, but by buying less than usual during each visit, Scott said. For instance, restaurant owners stop in more often and buy a day’s supplies at a time, which stretches out that cash flow and reduces spoilage.
At a time when the U.S. retail sector is in the throes of its worst stretch in years, Wal-Mart may be the one retailer that investors want to own. The world’s largest retailer, Wal-Mart last month reported a 10% jump in its third-quarter earnings per share. The company’s sales jumped 10%.
That performance is a big part of the investment case for Wal-Mart: Here we are, a year into a recession, and Wal-Mart, a retailer, is posting a double-digit gain in profits, and a healthy single-digit increase in sales.
This apparently counter-intuitive trend is actually a typical phenomena reserved for market leaders who also enjoy cost leadership in their own industry.
Let me explain.
In any industry – and especially one in which one firm’s wares can be easily substituted by those of a rival (which is very true of retailing) – the key to survival is to have a cost advantage over the competition. As demand falters, the low-cost player is able to under-price its rivals, attract additional traffic, gain market share and thrive, while the weakest players get squeezed right out of the business.
In the retail sector, this is playing out like a Harvard Business School case study. For November, Wal-Mart’s comparable-store sales increased 3.4%, while most of its competition saw actual sales declines. Even consumer-products king Procter & Gamble Co. (NYSE: PG) is showing that its sales through Wal-Mart are increasing, while sales through other retailers are down.
Wal-Mart’s unrivaled ability to buy in huge volumes allows it to obtain extremely favorable pricing from its suppliers. If those suppliers want to deal with Wal-Mart, they must accept the razor-thin margins the retailer affords them. Any supplier that even thinks about balking need only remember what happened to Rubbermaid Inc.
Back in the early part of the 1990s, in what is now regarded as a classic example of the market power that Wal-Mart was able to amass, consumer-products giant Rubbermaid Inc. found that rising oil prices were forcing up the cost of the ingot-like plastic balls that served as the raw material for its ubiquitous plastic storage tubs. Following what was then standard industry procedure, Rubbermaid tried to pass those higher expenses along to Wal-Mart in the form of higher product prices.
But Wal-Mart, known for its “falling prices” philosophy, not only balked – it fought back. It not only refused to pay the higher prices, it ordered Rubbermaid to find ways to cut the prices of its wares – even in the face of steeply rising raw materials prices.
When Rubbermaid refused, Wal-Mart slashed the amount of shelf space devoted to the Rubbermaid products, and gave the space to a little-known, privately held firm called Sterilite Corp., which had started life as a maker of plastic shoe heels that had the sad propensity to melt. So Sterilite switched to making plastic containers for the home.
Rubbermaid never recovered, and in 1999 it was forced to merge with Newell Inc. to form Newell Rubbermaid Inc. (NYSE: NWL). Rubbermaid remains the No. 1 maker of plastic storage containers. But after having come out of almost nowhere, Sterilite is today No. 2.
So in addition to being the “channel commander” – with an ability to dictate terms and prices to suppliers – Wal-Mart’s very lean cost structure and high efficiency from its highly-optimized logistics operation allows it to minimize corporate fat like no other and translate those savings into low pricing for its customers. With Wal-Mart’s sophisticated integrated sourcing-and-distribution system, competing on cost across the board against them is simply not possible for any of its competitors.
And consumers know it.
As Wal-Mart CEO Scott noted in his “Meet the Press” interview, even with gasoline prices way down, consumers are hunkering down. With unemployment already at 6.7% – and rising fast – the increasing ranks of the unemployed and underemployed alike have already slashed their spending. And even the folks who have kept their jobs are worried – and are acting accordingly.
The drop in home prices and the evisceration of savings and retirement brought on by a bear market that’s vaporized some $6 trillion in shareholder wealth add the final brush strokes to what was already a very dark economic portrait. Consumer confidence has plunged, and consumers are keeping their wallets in their pockets, partly to boost savings.
It’s an environment in which consumers and companies alike are well advised to employ a defensive mindset every bit as aggressive as the Pittsburgh Steelers. But not Wal-Mart. Instead, the retailing giant has gone on the offensive and is attacking the marketplace with the gusto that’s more like the Drew Brees-led New Orleans Saints.
In short, even though so many consumers are employing a back-to-basics mindset, as CEO Scott described, Wal-Mart isn’t sticking with just food and consumer staples. The chain is taking advantage of troubles in the electronics marketplace with the bankruptcy of Circuit City Stores Inc. (OTC: CCTYQ) and is even making huge inroads in electronics against Best Buy Co. Inc. (BBY).
For example, Wal-Mart is marketing both the Apple Inc. (AAPL) iPhone and Google Inc. (GOOG) G-Phone. It’s also is resorting to proactive advertising of discounts through text messages and other aggressive tactics in order to highlight its discounted merchandise and bring customers to its stores. Needless to say, the strategy is working extremely well.
But what about the change in leadership? Neither I nor most of the analyst community expected the recent announcement that Scott, 59, would be stepping down as the retail giant’s CEO, effective Feb. 1. But Scott is being succeeded by Michael T. “Mike” Duke, 58, head of the company’s overseas operations, and an executive with substantial global experience. So I am both comforted and optimistic.
I see continuity in Wal-Mart’s core strategies and, if anything, an invigorating shot into Wal-Mart’s overseas strategies.
In fact, this executive shift should play out extremely well for Wal-Mart. With the announcement of its record fourth-quarter sales and earnings back in February, Wal-Mart Stores Inc. (WMT) became the world’s first $100 billion retailer. With an increasing penetration of China, and continued, unabated success even in emerging market countries such as Mexico that have been affected the most by the ongoing U.S. financial-crisis-spawned recession, Wal-Mart is ready to reap the growing benefits of its international foray.
Next year, while the world’s most-advanced economies will be barely growing in the aggregate, emerging economies will post growth of between 3% and 8%, led by China. This should enable the retailer’s overseas sales to climb by as much as 10%, in spite of the global turmoil.
In conclusion, the U.S. recession should translate into increasing market share gains for Wal-Mart here at home, while an increasing penetration into the much-faster-growing economies abroad will help propel both the top and bottom lines for the company. With a Price/Earnings (P/E) ratio of 15 and a very-low EBITDA multiple of only eight, this defensive profit play is poised to continue delivering capital appreciation and market outperformance in the New Year, despite a very difficult backdrop. Wal-Mart should be a core stock in virtually every portfolio.
ACTION TO TAKE: BUY Wal-Mart Stores Inc. (NYSE: WMT), but do so with some care. Buy half a position today and leave some powder dry to complete the position in the first quarter of the New Year, since volatility will remain with us for some time to come. **
[Editor’s Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises – cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with his newly created "Money Moves Alert" specialized trading service. "Buy, Sell or Hold" is a Money Morning feature that has most recently analyzed such companies as Hewlett-Packard Co. (NYSE: HPQ), Apple Inc. (Nasdaq: AAPL), Google Inc. (Nasdaq: GOOG), or the Brazilian ETF, theiShares MSCI Brazil Index (NYSE: EWZ), which rose 42% in the six days after Marquez rated it as a “Buy.”]
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** Special Note of Disclosure: Horacio Marquez holds no interest in Wal-Mart Co. Inc.