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Dow 30 Profile: Wal-Mart
Wal-Mart’s (WMT – Free Wal-Mart Stock Report), status as the world’s largest retailer has cemented it firmly within the top five of Dow 30 companies in regard to market cap. Strategies such as expanding into underserved markets, keeping wages low, pioneering distribution techniques, and wielding bargaining power over vendors have allowed Wal-Mart to provide industry leading “everyday low prices” and change the way a significant portion of the global population buys common goods, in turn, making it the most powerful corporation in the retail industry.
A Resourceful Leader
The origins of Wal-Mart date back to 1945 when Sam M. Walton opened a franchise Ben Franklin variety store in Newport, Arkansas. Over a decade later, Mr. Walton began to consider transitioning from variety stores to the budding discount subsector after visiting a Houston-based FedMart (a discount department store open only to government employees who paid a nominal membership fee in exchange for relatively inexpensive, high-volume wares). After a few eye-opening meetings with some of the 100, or so, first entrants into the discounting field, he launched Wal-Mart Discount City, in 1962 in Rogers, Arkansas. Mr. Walton was not shy about showing esteem, and would later tell FedMart founder Sol Price his success was “all thanks to you”.
Truth be told, Mr. Walton didn’t originate many of the retailing concepts that his chain would eventually come to epitomize. His one seemingly innovative idea in the beginning was more a result of the company’s restrictive capital budget than a pioneering vision. However, he managed to eventually realize that less affluent rural Americans would buy in large volumes when presented with household brands at bargain prices. This fact eluded larger rivals like Kmart (SHLD) and Woolworths, which were only moving into the suburbs of large cities with wide customer bases to increase traffic. Meanwhile, Mr. Walton was methodically expanding his footprint throughout small towns in the southern United States, and placing highly efficient distribution centers in the middle of the sprawl.
After conquering the Ozarks and surrounding areas, Wal-Mart set out to move beyond its native market and expand from 32 stores in 1970, to 276 in 1980, to 1,726 by 1990. This growth would not have been possible if not for the notoriously tightfisted Mr. Walton’s ultimate decisions to invest in the cutting-edge technology presented to him by subordinates. He recognizes David Glass for developing much of Wal-Mart’s highly efficient protocol. Mr. Glass succeeded Mr. Walton as CEO, serving between 1988 and 2000, and helped the business increase from 123 stores in 1976 to 2522 outlets upon his departure. Many of the innovations he introduced would eventually become the foundation of modern retailing logistics.
The major developments implemented in the last two decades of Mr. Walton’s career include the tracking of inventory with computers in 1969, the introduction of barcode scanners in 1980 (which reached a 90% store penetration by 1988), use of electronic data interchange (the structured transmission of data between organizations by electronic means) in 1985, and construction of America’s largest private satellite-communications network in 1987. The latter allowed Wal-Mart to transfer significantly more data compared to conventional telephone lines, and, in turn, precisely monitor the location of goods and how fast they were selling. Executives used this technology to quickly adjust distribution according to each region’s demand dynamics, providing a tremendous advantage over competing information systems.
Everyday Low Cost
Although Wal-Mart has a best in class distribution system, it would be nothing without the relatively low-cost wares being transported. Due to the company’s mammoth size, and predominantly centralized purchasing, it makes enormous orders and wields significant, if not absolute, bargaining power over merchants, depending on their size. For most vendors, these are the biggest invoices they record for any given time frame, and even though the per unit prices are likely to be significantly lower than those received from other retailers, they are willing to deal because once their products are brought into the Wal-Mart system they usually improve market share and brand loyalty. Although product margins routinely suffer, many times the volume gains more than offset this, and the supplier’s cash flow is better off than not selling to the company.
Mr. Walton once said, "I pay low wages. I can take advantage of that. We're going to be successful, but the basis is a very low-wage, low-benefit model of employment." Indeed, a study by the Los Angeles Alliance for a New Economy claimed that Wal-Mart pays 20% less than the average retail salary. Wal-Mart managers tend to be judged based on their ability to control payroll costs, which is why overtime is discouraged. The company’s annual report says it “experiences significant turnover in employees each year”. Although specific numbers are not revealed, management has admitted the turnover rate was once as high as 70%. We believe this number has fallen due to the need for employees to hold on to their jobs during troubled economic times. However, it is likely still around double Costco’s (COST) turnover rate, as that company is well known for paying its employees above the average retail industry wage and providing generous benefits packages. As far as healthcare goes, we estimate Wal-Mart insures around half of its 2.1 million employees, compared to approximately 95% for Costco. Obviously, above-average healthcare costs are viewed negatively by investors, and that is a price Wal-Mart is clearly not willing to pay.
The Rise of the Supercenter
The primary growth engine for Wal-Mart over the past two decades has been the supercenter. These stores combine a standard discount store with a supermarket, tire and oil change shop, optical center, one-hour photo processing lab, etc. all under one roof. They average 185,000 square feet in size, which compares to 108,000 for original discount stores and 42,000 for Neighborhood Markets (which compete more with conventional grocery stores). The first supercenter opened in 1988, and 2,746 more have opened since then. This store format now accounts for 57% of the total store count, which includes international locations and the Wal-Mart owned membership warehouse club chain Sam’s Club. This meteoric rise has not come without growing pains, as the company has endured countless lawsuits, protests, and stop work orders over the years from municipalities, labor unions, community groups, and local businesses that can’t compete with the company’s low prices and breadth of product offerings. All this creates negative press, which has motivated a significant number of U.S. consumers to flat out refuse to shop at Wal-Mart stores. These people are usually more affluent, and generally prefer to shop at Target (TGT) or Costco, companies that are regularly perceived to have more friendly operating practices. The people’s perception of Wal-Mart appears to be a concern for some investors. When questioned, executives are quick to point out positive effects their business has on society like $4 generic subscriptions and no landfill waste in most states, as well as $2 billion in planned donations to the hungry. Still, it’s difficult to keep growth high and costs low without angering some people, and we view public relation and legal challenges as an ongoing element of the company’s business model.
Great Recession = Stock Price Depression
During the economic downturn of the late 2000s, the company made some headway with more affluent customers as many chose to “trade down” from relatively expensive grocery stores for general merchandise. During this time WMT got rid of “Action Alley” or large discount bins in the middle of wide isles to reduce the appearance of clutter. Also, the value proposition of women’s apparel assortments declined when more fashionable, higher-cost items were introduced. We believe these were attempts to win market share from Target. Although management claims it did succeed in gaining new business from higher-income clients, visits from its core customer base (households with income under $70,000) fell, leading to less-than-stellar same-store sales over the last several quarters. In addition, we believe many core customers visited dollar stores more frequently in response to Wal-Mart’s initiative to remove some products from certain categories. Management’s initial plan was to invest heavily in growth areas and to reduce exposure to down-trending categories. But it found that by cutting some assortments by up to 20%, customers were not finding everything they needed and, thus, were going elsewhere. Too, certain large vendors with enough bargaining power to pull products from Wal-Mart’s shelves were also leaving as they would not accept the lower invoices.
U.S. Retail Recovery
In response to the aforementioned missteps, the company took an aggressive “back to basics” approach to rightsizing its business. First and foremost, it added back thousands of items —primarily in its food departments— to ensure customers find what they need, when they need it. Along a similar vein, it made changes to its protocol in order to improve inventory replenishment and avoid empty shelves. Realizing the value of discount bins, the company also brought Action Alley back into the mix. The company also hired a new apparel chief who has been focusing more on basic branded apparel like underwear and socks. In general, Wal-Mart is trying to do fewer “rollbacks” or discounts, instead choosing to revive its “everyday low price” model through aggressive price competition. Wal-Mart’s top priority is now pure and simple: offer the lowest prices around, and if a competitor’s price is lower, beat them. This strategy served the company well over the 2011 holiday season when its price match guarantee proved effective. The return of the layaway program also helped revive comps during that all important shopping season. The company hopes to reduce prices by a staggering $2 billion over the next two years in order to increase loyalty, increase traffic, and win back customers that were lost to dollar stores during the downturn. Although it will be making sacrifices to its own product margins to accomplish the price cuts, WMT will also pressure suppliers to lower wholesale prices. Recent changes appear to be resonating with customers as comps turned positive in late 2011 after years of declines. Still, Wal-Mart’s core low-income customer base remains extremely financially challenged due to still high unemployment rates and indebtedness. Although certain parts of the U.S. economy have improved of late, it appears that many of Wal-Mart’s shoppers will continue to be strapped for cash for some time yet. Indeed, management says the “payroll cycle” remains pronounced, with shopping activity spiking on paydays.
Outside of the domestic business Wal-Mart seems primed for growth overseas. Store openings in China, Brazil, and India have been rampant, a trend we don’t expect to reverse anytime soon. In mid-2011 Wal-Mart’s acquired a 51% share of Massmart Holdings, a group of South African retail chains with 288 stores focused on high-volume, low-margined, low-cost distribution of mainly branded consumer goods for cash. The company also increased its U.K.’s store count when the Asada chain acquired Netto for $1.13 billion in mid 2010. Wal-Mart is also getting better at directly sourcing produce and other local goods, which should help it continue increasing revenues faster than costs for the foreseeable future. Too, when local produce doesn’t make sense, the company is working on making the supply chain more global. In general, the company is focused on catering to local tastes in an attempt to improve customer loyalty.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.