Wal-Mart: A retail behemoth positioned for growth

Standard and Poor’s Equity Research Services (ERS) has a positive fundamental outlook for hypermarkets and super centers. S&P’s Senior Industry Equity Analyst, Joseph Agnese, believes economic strains on lower income consumers has led to increased price sensitivity and intense pricing competition among retailers. Despite an expectation for economic pressures to persist in the near term, particularly on lower income consumers, Agnese believes super centers are favorably positioned with square foot expansion expected to continue through 2011. Standard & Poor’s Hypermarket and Super Center index increased 2.6% year to date through October, versus a 6.1% rise in the S&P 500 index.

Hypermarkets and super centers reported sluggish year over year same store sales growth in the first half of 2010. Agnese sees club operators posting same store sales growth in the low to mid single digits, excluding gasoline sales and foreign exchange impacts, as their leadership on low prices and high quality product offerings attract increased traffic levels in the second half of 2010. He looks for club store operators’ profitability comparisons to ease over the next 12 months, as the macroeconomic environment stabilizes and as earnings comparisons become more favorable.

Agnese believes Wal-Mart Stores Inc., in particular, is well positioned to benefit in the next few years from a new merchandising strategy, the implementation of a new store format strategy, an expected return of food inflation in 2011, and a new focus on its low priced basics product offerings.

Wal-Mart faces a number of challenges including winning back consumers who are trading down to dollar stores, regaining customer loyalty after eliminating a significant number of branded SKU offerings as part of its Project Impact strategy, the lack inflation within its food offerings, and ongoing promotional pricing amongst its vendors. These challenges are reflected in the company’s five consecutive quarters of declining comparable store sales, including a 1.8% decline in its fiscal 2011 second quarter ending in August.

While the company guided October quarter comparable store sales growth in the range of down 2% to up 1%, Agnese believes sales will be flat in the quarter as the implementation of a new merchandising strategy gains customer traction. Agnese believes it will take time for customers to realize their favorite brands have returned, for instance. Additionally, other factors have yet to turn in the company’s favor, such as ongoing food deflation pressures and increased promotional spending by vendors.

Consumers should eventually respond as Wal-Mart once again becomes the trusted retailer for consumers to find their favorite branded products. Additionally, rising commodity prices are expected to eventually lead to inflation in 2011 as the higher costs work their way through the food distribution channel, likely leading vendors to eventually raise prices.

New management at Wal-Mart has initiated significant inventory changes. Bill Simon recently took over as the new CEO of Wal-Mart’s U.S. operations from Eduardo Castro Wright. Simon is increasing branded SKU count offerings over the next few quarters as the company returns important brands back to its shelves. While this should result in inventory growing faster than sales in the near term, Agnese believes this is a necessary requirement to regain customer loyalty and lost sales while helping drive future growth. In regards to assortment, the company expects to focus on its strength of competitively priced basics. Additionally, pallets of merchandise are being reintroduced to Action Alley, along the main shopping aisles, after efforts to clean up the shopping experience eliminated this important sales driver.

The company is implementing a new small format strategy in an effort to drive future sales growth, while square footage expansion generated from both the conversion of discount stores to supercenters and new supercenter openings is down significantly from historical levels. A new three format strategy will be used to help fill in between supercenters and to gain entry to urban markets and small towns. The large format will continue to be the supercenter, in which Wal-Mart expects to open 155 to 165 units in its fiscal year ending January 2012, up slightly from it projection of 152 units in fiscal 2011. A medium format will be between 30,000 and 60,000 square feet, or the size of its Neighborhood Market format. The small format is expected to be less than 30,000 square feet and be used in urban markets and small towns. The company projects the opening of 30 to 40 small and medium sized formats in fiscal year 2012.

Due in part to new job opportunities for local residents, the company has had an easier time gaining approval for new store expansion in Chicago, a recently entered urban market. At its analyst meeting on October 13, 2010, the company alluded to expansion opportunities in New York City, a target that has been unachievable due in large part to organized labor actions to prevent its expansion. The company will likely make use of its small and medium formats due to space constraints in the New York City market.

Agnese has a strong buy opinion on Wal-Mart Stores, Inc., a buy opinion on BJ’s Wholesale Club, and a hold recommendation on Costco Wholesale Corporation.

S&P employs a proprietary methodology for ranking mutual funds and exchange-traded funds (ETFs); rather than looking only at past performance, S&P also incorporates analysis of the underlying holdings and their likely future prospects, as well as risks and costs. Funds or ETFs that hold stocks viewed as undervalued by S&P equity analysts are more likely to get a high ranking from S&P’s proprietary quantitative ranking tool.

Many mutual funds or ETFs hold one or both of these stocks as a top-ten holding; the mutual fund table screens out those that garner a five-star ranking from S&P, are open to new investors with no load and a minimum initial investment of $10,000 or less, and overall assets of $50 million or more.

Similarly, many ETFs hold Wal-Mart as a top holding; this list contains those that garner an “overweight” ranking from S&P.

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