February 24, 1999
Wal-Mart Bear's Den
by Paul Larson (email@example.com)
I'm certainly facing an uphill battle here by arguing against one of retailing's most successful names in history. Who doesn't like Wal-Mart here? What, are you a communist? Wal-Mart was recently named as America's most admired retailer by Fortune magazine. Don't you realize how many billions of dollars have been made by the folks in Bentonville, Arkansas? Oy vey, this isn't going to be easy.
Let me cut to the chase. I see Wal-Mart as an aging superstar staring at the twilight of an illustrious career. There's nothing wrong with the company per se; it's just that I see future growth coming with much more difficulty than the company has experienced in the past. Wal-Mart is also sporting the valuation of a sleek growth stock when it more closely resembles a lumbering giant.
Just how giant is Wal-Mart? Consider the following. Wal-Mart has more than 1,000 employees (or as the company calls them, associates) for every single word in this argument. If that doesn't give pause for thought, consider that the company is so big that nearly 1 in 200 working-age adults in the U.S. work for Wal-Mart. Imagine, if you can, cutting over 900,000 paychecks every two weeks. To hone my skills at pointing out the obvious, that's a lot of employees, and that's a lot of stores.
One of the major problems with such enormous size is that it starts to make the company much less nimble. But more importantly, at Wal-Mart's late stages of development the new opportunities for building its business start to be severely limited as the concept reaches its saturation point. There are simply not many communities out there that aren't already served by Wal-Mart or one of its competitors.
Even if Wal-Mart hasn't hit the saturation point just yet, it can't be too many more years before America has all the Wal-Marts it can handle. And when that happens, the company's growth momentum will slow to a halt. Plus, it's not like the company is churning out stores at a breakneck pace these days. Total unit count, including international stores whose success is much less certain, is only expected to increase by slightly more than 5% this coming year. Still feel like paying 40x forward profit estimates for a retailer? "Every day low prices" may be the motto inside the store, but today it is a completely different story with the stock.
Looking to the company's future competitors, we find much worthier rivals than what Wal-Mart has faced in the past. On the discounter end, the company is seeing increased competition from a refreshed and more focused Kmart (NYSE: KM) as well as a significant challenge from Dayton Hudson's (NYSE: DH) Target stores. Speaking of Target, the retailer is expected to increase the number of stores it operates by roughly 9% over the next year. Many of these stores will be in markets where they will be competing directly with existing Wal-Mart's. Unlike the mom 'n pop stores Wal-Mart was battling against in yesteryear, Target is no pushover. Quite the opposite, really.
On the warehouse side of the business, the competition looks even meaner. Costco (Nasdaq: COST) is spanking Wal-Mart's Sam's Club on most fronts, including some key efficiency metrics. The most notable difference lies in the sales per square foot of retail space. Costco's sales are nearly 85% higher on a per-area basis than at Sam's. Wal-Mart may be the current king of the discount retailers, but in the warehouse segment there appears to be another company occupying the throne.
Sam's Club is only expected to increase its unit count by 3% in the coming year. Costco, on the other hand, is expected to have a slightly more robust 5% growth in its store count over the same period. Much like Target, some of Costco's newest stores will be in markets already served by Wal-Mart and Sam's, including my local area. In fact, a Costco recently opened near me, and I have promptly canceled my long-running Sam's membership in order to join the ranks of the happy Costco shoppers. Will I be alone in my defection? Somehow I doubt it.
To conclude, if Wal-Mart were trading at half the price it is today, I might actually consider buying the stock. Few companies know how to squeeze a penny harder than Wal-Mart, and I don't doubt the existing stores will continue to be profitable. But trading at 40x optimistic forward profit estimates, the company needs to do much more than just stand pat to justify its price. At a premium valuation with future growth a highly questionable proposition, I have a sinking feeling that the price of Wal-Mart's merchandise is not the only thing set to roll back a bit.