by Will Ashworth | February 20, 2014 10:40 am
Walmart (WMT) reported disappointing Q4 earnings Thursday morning, its first under newly appointed CEO Doug McMillon. Business at the world’s largest retailer continues to suffer from economic and competitive headwinds. Meanwhile, rival Target (TGT) works its way through its own issues, including a huge customer data breach.
In short, neither company is firing on all cylinders.
In recent years TGT stock has flatlined, achieving an annualized total return of 5.3% through February 19. That’s 789 basis points lower than WMT stock and 824 bps less than the S&P 500. One stock looks like a better buy at the moment, but let’s dig into the details to see if that’s really true.
Buy American: Walmart has pledged to buy an additional $250 billion in American-made products over the next 10 years. You can be as cynical as you want about its decision, but this moves the company a little closer to its founder’s vision. In the 1980s, Sam Walton encouraged Walmart buyers to buy American-made goods when it was cost competitive. It didn’t mean WMT would buy all of its merchandise in the U.S. — just that it would try where possible. The same holds true today, but in this case the company has put an actual number to the pledge. If WMT stock has any hope of taking flight, it needs Americans to increase their spending at its stores. American-made products are one way to get them to do that.
Canada: Target’s not the only discount retailer making a splash north of the border. WMT announced Feb. 4 that it’s spending $451 million in Canada over the next year to open 35 supercenter stores — including groceries, pharmacies and all the other things normally associated with its bigger footprint. By the end of January 2015, Walmart will have 395 stores in Canada, including 282 of the supercenter variety. That’s almost three times as many as its Minneapolis rival. With additional funds invested in its distribution network and e-commerce business, WMT stock should benefit from the head-to-head competition.
Doug McMillon: In late December, I ranked five newly appointed CEOs on how they’d perform in 2014. Walmart’s new boss was on the list, having moved over from the top job at Walmart International. I concluded that his relative youth — he’s 47 — along with his experience operating a business that’s actually growing will help him fix the ailing WMT stock. A few months later, I’m standing by that assessment. McMillon can be a great leader for the company and for WMT stock.
So, what about the competition? Well…
Canada: My home country is in the midst of a huge transformation. It’s not just Target and Walmart that are altering the retail landscape but businesses from all over the globe. Nordstrom (JWN), Saks and many others are making a bid for the disposable income of Canadians from coast to coast. Even domestic retailers like Toronto’s Loblaw Companies (LBLCF) is getting into the act, buying Shopper’s Drug Mart (SHDMF), Canada’s largest drug store chain. On several occasions in the past two years, I’ve gone to bat defending Target’s Canadian expansion. Despite the many concerns, my tune’s not changing — TGT stock will take flight once it works out the bugs in its Canadian operation.
Data Breach: Up to 110 million Target customers were affected by the security breach, which affected mostly email addresses. The Wall Street Journal reports that chief marketing officer Jeffrey Jones was concerned that revealing such a large number would seriously affect TGT stock, despite the fact less than 40% of the breach was truly serious in nature. But CEO Gregg Steinhafel overruled, stating, “Target won’t be defined by the breach, but how we handle the breach.” In the end, it might cost Target a billion dollars or more but this was a character revealing moment. TGT stock will take a hit in the short-term but it’s handled this problem with grace and humility … unlike Walmart, which tried to sweep its Mexican bribery scandal under the carpet.
Put and Call Options: While Target’s Q4 earnings (expected February 26 before the markets open) will see the worst quarterly decline since 2006, the options market seems to like the long-term future of TGT stock. On Feb. 5 a put option betting on a 10% decline cost only 2.79 points more than a call option betting on a 10% gain. The higher the skew, the more bearish a view taken by option traders. More fuel for the fire — on Feb. 7 the put-call ratio hit its lowest level in 18 months. According to Bloomberg, option traders haven’t been this bullish about TGT stock since July 2006. While this isn’t enough to get TGT stock heading in the right direction, it’s a sign its earnings problems and data breach to a certain extent are already priced into its stock.
Of the two companies WMT stock has much lower volatility over the near-term. However, I believe, perhaps naively, that TGT stock will get through this data breach becoming a better company as a result.
Data breaches are a fact of life in a technology-driven society. Target will learn from this mistake as TJX (TJX) did in 2007, mitigating the damage for TGT stock. As for Canada, the company has invested too much already to turn back now. Time will solve its problems north of the border.
Call me crazy, but if the horse race between TGT stock and WMT stock is for the next 3 to 5 years, Target wins.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.
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