We’re heading into the busiest time of the year for retailers, which means it’s time to look at who’s will come out of the holiday season on top.
Walmart (WMT) and Target (TGT) have a lot riding on the holiday season, and there are plenty of questions up in the air about the discount giants. How are they doing as we enter the 2013 homestretch? Do they have what it takes to grow in 2014? What’s their long-term prognosis?
I’ll take a look at different aspects of both businesses, and pick a winner.
Target’s most obvious move is its Canadian expansion. In August I wrote about the problems it was having north of the border, all focusing around customer service, or the lack thereof. By the end of the year TGT expects to have 124 stores open coast to coast, from a standing start of none at the end of February. That’s quite an accomplishment regardless of its mixed results, but so far, Target has missed the mark in almost every conceivable way.
TGT hasn’t lost its confidence, though. CEO Gregg Steinhafel told analysts Wednesday, “Initial sales in Canada have fallen well short of expectations … [But, we remain] confident we will reach our long-range financial goals in our Canadian segment.” Those goals call for $6 billion in revenue by 2017, although the Target Canada website suggests it could take up to 10 years. Regardless of the timeline, I’ve gone on record several times suggesting that the number is in fact … too low. You might not think so now but Target is going to get the job done.
Walmart’s big initiative right now is its full-court press on holiday shopping. With comps in the dumper, it’s matching Black Friday prices from Target, Best Buy (BBY) and others. The Deals will start Nov. 22, six days before Thanksgiving, when it will open its big sales event two hours earlier at 6 p.m. Bill Simon, Walmart’s head of U.S. operations had this to say about the event: “Black Friday is our day — our Super Bowl — and we’re ready to prove once again that no one does it better than Walmart.”
While it’s true Black Friday ranks as the biggest shopping day of the year, these moves hardly sound like the bold initiatives needed to keep the world’s largest retailer growing long-term. As InvestorPlace‘s Adam Benjamin points out, its troubles in China, Brazil and India seem far more pressing to its long-term success than any moves it makes on turkey day.
When earnings are in flux, as they are with TGT, we need to move away from the traditional earnings-based valuation metrics to measures not directly tied to the bottom line. Looking at price-to-sales and price-to-book, the two stocks are almost identical in their valuation multiples. Historically, both are also trading around their five-year averages with Walmart’s P/B a tad higher than normal. But there’s certainly nothing out of the ordinary that stands out for either stock.
To break the stalemate I thought I’d look at each company’s operating cash flow as a percentage of its market cap, essentially flipping the P/CF ratio providing an operating cash flow yield. (I’ve used operating cash flow instead of free cash flow because of Target’s increased expenditures for Canada.) In this example, Target’s OCF yield is 13.2%, 360 basis points higher than Walmart’s. Once Target reaches its more normalized level of margins in Canada, I believe this gap will widen.
The numbers are in, and they aren’t pretty for either retailer.
Target announced Q3 earnings Thursday, and the obvious blemish in its press release is the 46% drop in net earnings — down to $341 million on $17.3 billion in revenue. The quarter looks a little better if you back out the Canadian business, with a 2% increase in revenue year-over-year, and a 0.9% same-store sales increase.
Canada’s EBIT loss for the first nine months of the year is $612 million or $0.95 per share. On the surface, that’s tough to swallow, but investors knew these losses were coming — you don’t open 124 stores in one year without a whack of overhead hitting the books. Going forward, TGT should see a ton of improvement just by opening more stores and sharing expansion costs over a wider network.
Walmart’s Q3 earnings were less than stellar, but it did manage to grow them by 2.8% year-over-year — up to $3.73 billon. Unlike TGT, the company is at least heading in the right direction. That comparison is a bit unfair, however, because Target’s Canadian operation is still in start-up mode. Walmart’s international outposts, including Canada, are fairly mature with better margins. A fairer comparison is to examine both companies’ U.S. operations.
In the third quarter, WMT same-store sales dropped by 0.1% in the U.S. — its third consecutive quarter with declining comps. Target’s comps were up 0.9% in Q3, although both companies missed analyst estimates. Walmart’s operating income in the quarter grew 5.8% to $5.1 billion. Target’s declined by 8.8% to $1.5 billion. On the top line, Walmart’s revenues increased 2.4% in the quarter compared to 2% for Target.
I’ll keep this short and sweet.
WMT doesn’t appear to have many catalysts that can make its stock move. TGT, on the other hand, has two potential catalysts that aren’t currently reflected in its stock. The first — Canada — is a huge shadow hanging over the company. Uncertainty creates buyer reluctance. Until investors can see the light at the end of the tunnel, its stock will remain under pressure.
The second catalyst is its U.S. segment, which needs to lower its SG&A margin. To that end, it announced in October that it was laying off 150 employees at its Minneapolis headquarters. While it’s never fun letting people go, one look at its income statement speaks volumes about its cost controls. It can and will do better.
I’ve recommended Walmart in the past, and I think it makes a decent core holding in most portfolios. But when compared directly to Target, there’s no confusion — Target’s the better stock for the next 2-3 years.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.