Smaller Bricks, Growing Clicks is the Big Box Trend

When looking at their valuations, big-box retailers Target (NYSE: TGT  ) (NYSE: TGT  ) (NYSE: TGT  ) and Wal-Mart (NYSE: WMT  ) (NYSE: WMT  ) (NYSE: WMT  ) run practically neck and neck. With the two companies so close on most metrics, how do you decide which one to buy?

Smaller bricks
Both are decreasing their bricks and mortar presence as they expand online. Target won 10th place in Fast Company's list of the Most Innovative Companies of 2013, ahead of both Google and Apple for "shrinking the big box" with its CityTarget stores, which are a fraction of the size of regular Targets and carry inventory aimed at city dwellers.

The concept is so successful that Wal-Mart's own Neighborhood Market (306 units) and Wal-Mart Express stores (20 units), similarly downsized and personalized, will expand to 500 units by mid-2015.  Wal-Mart U.S. CEO Bill Simon said recently, "This is one of the fastest-growing formats in retail, 60% (net sales) growth , mid single-digit comps over the last couple of years."

The advantage for both big boxes with their little box stores is, as Simon said, "We have an understanding of what everybody in that ZIP Code buys online through Walmart.com, buys in bulk through Sam's Club, buys at the Supercenter down the road and can assort the store, a 10,000 or a 15,000 square foot store so that it feels like a much, much bigger store."

Bigger clicks
Wal-Mart, with its online ship-to-store policy, is turning showrooming on its head; the company has been encouraging shoppers to compare with a mobile app and price matching policy. Target soon followed, as Fellow Fool Rich Duprey details. Ship-to-store will be widely available in the back half of the year for Target.. 

Wal-Mart is doing well in its omni-channel, with in-store mobile apps and Scan and Go. Both companies' websites have been refreshed, with Wal-Mart's using a new and improved search engine. But Target is aggressively acquiring e-commerce sites like DermStore Beauty with its 26,000 stock keeping units, or SKUs, of beauty and skin care products , Cooking.com, and Chef's Catalog; the last two together total 30,000 cooking products.

Target has long differentiated itself from Wal-Mart with a focus on quality, as well as merchandise exclusive to Target. Its most recent and hotly anticipated 3.1 Phillip Lim (designer apparel collection) sold out online within hours. But it is not just another widely anticipated collaboration for Target. Target ramped up digital with the launch of their Cartwheel online, and mobile loyalty program.

Target CEO Gregg Steinhafel said of the Cartwheel mobile app:

...our partners at Facebook have told us that engagement statistics for Cartwheel are among the best they have seen in the beta stage of any app both within and outside the retail space...Second quarter sales in our digital channels grew in the teens overall with mobile traffic and sales continuing to grow at a triple digit pace.

Wal-Mart may have economies of scale and pricing power with 10,800 stores in 69 countries, but Target is a nimble and more fashion-forward centenarian totaling 1,856 U.S. and Canadian stores, with plenty of available room left to expand.

Target and Wal-Mart are valued similarly: respective trailing price-to-earnings ratios at 15.35 and 14.65, price-earnings-growth ratios at 1.55 and 1.60, and price-to-sales ratios at .55 and .52. Target has a slight edge on gross margin at 30% to Wal-Mart at 25%. Even the companies' dividends are close at 2.70% for Target and 2.50% for Wal-Mart.

Wal-Mart's 23.45% return on equity is higher than the 16.97% figure for Target. Then again, analysts give Target the edge on growth with an expected 10.45% five-year earnings-per-share growth rate to 9.13% for Wal-Mart.

Their challenged customers
The economy favors Target as its higher-income shoppers (average household income $64,000-plus) were more willing to shop last holiday season than Wal-Mart's under-$60,000 a year shopper, who felt the pinch of the Grinch. Now they're strapped by cuts in working hours and payroll tax increases. 

Wal-Mart's comparable same-store sales declined 0.3% in the second quarter, and it lowered guidance for third quarter comps and full-year EPS.Target reported slightly better second quarter U.S. comps (up 1.2%), but Steinhafel also warned of a cautious consumer.

Bigger's not better
Overall, Target is the most innovative in marketing and digital. Its e-commerce acquisitions remind me of Amazon's many niche e-tail sites, and it still has room to grow. Wal-Mart may have economies of scale and scaling-down, but with its weaker consumer, Target is the better buy.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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