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For most retailers, gaining a small fraction of a $500 billion industry would be enough to propel their revenue and earnings for decades. However, when your name is Wal-Mart (NYSE: WMT ) you need an industry of this magnitude to try to improve future growth. The industry that Wal-Mart has its eyes set on is the U.S. grocery store business. Wal-Mart's size and scope of operations give the company some advantages in comparison with traditional grocers. However, this is a cutthroat business and grocery sales could hurt the company's margins.
A massive opportunity for a massive company
As improbable as it sounds, Wal-Mart could grow faster than analyst expect if the company can take significant market share in the U.S. grocery business. With the company reporting that over 55% of its domestic sales come from the grocery category , the world's largest retailer is already heavily invested in this business.
In fact, over the last few quarters Wal-mart has specifically mentioned that it gained, "domestic market share in the category of food, consumables, and health & wellness." Most analysts expect the company to report over $480 billion in sales for the full year 2014. With nearly $50 billion in sales in the grocery business occurring domestically every month, you can see the size of this opportunity. Of course we have to take into account Wal-mart's existing market share. If 55% of the company's $68 billion in domestic quarterly sales is all grocery related that equates to about $37 billion in quarterly sales. However, the fact that Wal-mart reports food, consumables, and health & wellness, means the company may be including sales that aren't comparable to traditional grocers. Even if $10 billion a quarter in additional sales is achievable through taken market share, this would add nearly 9% to Wal-Mart's annual sales. Considering that over 245,000 people visit a Wal-Mart worldwide once a week, investors shouldn't be surprised if convenience converts a lot of people to grocery shopping at the world's largest retailer.
A huge distraction?
While the opportunity is vast, Wal-mart has to make sure that its grocery aspirations don't distract from the company's other businesses. It's certain that Wal-Mart's competition will look for any opportunity to steal sales.
One example is Amazon.com (NASDAQ: AMZN ) , which gets more than 60 % of its sales from electronics and general merchandise. In addition, Amazon already offers a grocery and other item delivery service in both Los Angeles and Seattle under the Amazon Fresh name . With "over 500,000 items" including groceries available with free same-day and early morning deliveries, any expansion of this business could be a huge challenge to Wal-Mart.
Target (NYSE: TGT ) also offers its own challenge to Wal-Mart. The company's expansion into Canada is in its early stages, and the company now offers at least an expanded grocery selection in more than 70% of its stores . The company offers higher-end clothing and home goods than its competition. Target brings in shoppers with other items and then sells groceries as a convenience.
Another competitor that already challenges Wal-Mart is Costco (NASDAQ: COST ) . Costco offers tons of options, but grocery and household items are the company's bread and butter. With multiple quarters of middle to high digit same-store sales , Costco's business model clearly works.
The bottom line is, if Wal-Mart hopes to steal market share in the grocery business, the company better keep its eye on the competition trying to take sales from the company on the other end.
Is there enough growth to offset margin pressures?
One of the big questions facing Wal-Mart is, can the company find enough growth to please investors? Analysts are calling for just over 4% revenue growth next year. If you look at more traditional grocers, this isn't a huge growth business.
Between Kroger, Safeway, and SuperValu, there isn't one with an expected revenue growth rate of more than a little over 5 %. It's possible Wal-Mart may steal market share, but what if this gain comes at the expense of the company's gross margin?
Looking at traditional grocers again, the average gross margin seems to argue for further challenges to Wal-Mart's margin in the future. Safeway's margin is nearly 26%, but Kroger and SuperValu's margins are both less than 21%. While Costco's margin of 12.43% is low, Amazon and Target both manage at least 28% gross margins.
This could be exactly what investors want
For a massive company looking for growth, Wal-Mart has no choice but to go after an industry the size of the U.S. grocery business. Though Wal-Mart has to walk a thin line between sales growth and margin pressure, companies like Safeway prove that it can be done.
With a decent yield of about 2.5%, Wal-Mart investors are being paid to wait. While analysts are calling for EPS growth of about 9%, stealing market share in a $500 billion industry could drive this number higher. With shares selling for around 14 times expected earnings, if this bet pays off Wal-Mart investors could be well rewarded.
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