Dueling Fools

Dueling Fools
Discounting Wal-Mart
February 24, 1999

Wal-Mart Bull's Pen
by Yi-Hsin Chang (tmfpuck@aol.com)

Mention Arkansas and most people think of the Razorbacks, Little Rock, our scandal-ridden president, or maybe Paula Jones. When I think of Arkansas, I think of one of the best companies in the world, Wal-Mart (NYSE: WMT).

Not only is the Bentonville, Arkansas-based discount retailer the king of discount retailers, it is the king of all retailers. With revenue of $137.6 billion in the year ended January 31 -- which, by the way, represented a 17% increase from the previous year -- Wal-Mart is ranked No. 4 among Fortune 500 companies (judging by Exxon's 1998 results, Wal-Mart should move up to the No. 3 slot on the next list), and it placed sixth in Fortune's latest survey of "America's Most Admired Companies."

More so than just about any other company, it's obvious why Wal-Mart has been so phenomenally successful. You know what I'm talking about if you've been to a Wal-Mart store or supercenter. Quite simply, the retailer engenders customer loyalty by offering quality service and value through its "Everyday Low Prices." Wal-Mart founder Sam Walton wrote the book when it comes to discount retailing.

To illustrate my point, I offer the unsolicited testimonial of a fellow Fool, Bob (TMF Bobala), who happened to stop at a Wal-Mart for the first time ever on his way to the beach over Presidents' Day weekend. Bob ran in wanting to pick up a few forgotten toiletries for his trip but ended up spending about $100. This is hardly an unusual phenomenon. It's exactly what naturally results from the Wal-Mart formula.

What's in the Wal-Mart formula besides putting the customer first and offering low prices? In a word, efficiency. Wal-Mart's highly automated distribution centers are strategically placed to best service nearby stores, thus cutting shipping costs and delivery time. Plus, Wal-Mart's inventory management system is the mother of all inventory management systems. The company's computers track every one of its products' every move. They know everything from how much the product costs and how many units of it a store has in stock and on shelves to what other items customers tend to buy along with it. The system is the model for "just in time" inventory management.

Don't be fooled by Wal-Mart's folksy appeal or the fact that the company's CEO, David Glass, doesn't have a computer in his office. If anything, Wal-Mart is something of a stealth tech company. More than 90% of the software the company uses is created in-house by 1,000 full-time developers so that the programs are tailor-made for its business. Remarkably, due to economies of scale, Wal-Mart still spends less on technology, as a percentage of sales (0.5%), than others in the retail industry (1.4%).

Underscoring the importance of efficiency, most employees at Wal-Mart take part in incentive programs whereby they earn bonuses based on the company's productivity and profitability.

And Wal-Mart certainly has been profitable. Last week, the company reported record fiscal 1999 net earnings of $4.4 billion, a 26% increase from $3.5 billion the year before. That's significantly stronger than the 15% and 12% growth it saw in the preceding two years. Last year, Wal-Mart's shares soared upward 106%. For the past decade, the share price has appreciated 938% -- 26% compounded annually. Not bad for a mature company.

But despite Wal-Mart's storied past, what impresses me most about the company are its prospects for the future. First of all, the fact that there are people like TMF Bobala who've lived 30 years without experiencing the wonders of Wal-Mart shows that there are still plenty of growth opportunities here in the U.S.

Secondly, even though Wal-Mart has made great strides expanding its business abroad, its global footprint still only covers a tiny part of the globe, especially population-wise. The company now operates 153 stores in Canada, 416 in Mexico, 95 in Germany, 15 in Puerto Rico, 14 in Brazil, 13 in Argentina, 5 in China and 4 in Korea. It has a strong presence in North America, but it has seen just the tip of the iceberg in both Europe and Asia (home of 3.4 billion potential Wal-Mart shoppers).

What's really exciting are the rapidly expanding Wal-Mart supercenters and the still-being-tested complementary business, Wal-Mart Neighborhood Markets. The supercenters, which are combination discount and grocery stores, are to Wal-Mart what Old Navy is to Gap Inc. (NYSE: GPS) -- they are the key drivers of growth. In the year just ended, the company opened 123 supercenters, 88 of which replaced the traditional discount stores. The supercenters allow Wal-Mart to compete in the $450 billion grocery business. After all, people shop for food at least twice as much as they shop for goods.

The neighborhood markets, nicknamed Small Mart, are essentially scaled down versions of the superstores (measuring about a fifth to a third in size) with an emphasis on convenience. They are combination drug/grocery stores with a one-hour photo lab, a dual drive-through pharmacy, multiple checkout lanes, two separate front entrances for the grocery and drug sides of the store, and more parking spaces closer to the doors. Basically, this is Wal-Mart's idea of a convenience store. It's brilliant. Why shop at a 7-Eleven or a Kwikie Mart when you can get a better selection and better service at better prices?

The Wal-Mart supercenters and neighborhood markets effectively deliver a one-two punch not just at discount department stores but also at supermarkets, drug stores and convenience stores. According to one study, three years after a supercenter opened, local grocery stores had lost an average of 17% of sales.

I envision a future where Wal-Mart supercenters and neighborhood markets dot our landscape, offering quality goods and services at low prices, putting the competition in its place, and in turn delivering high returns for the company's shareholders.