How Is Wal-Mart Faring Against Kroger and Costco?

As the largest retailer in the world, is Wal-Mart too big to continue its excellent track record of growth? And are companies like Kroger and Costco waiting to grab a greater share of the retail market -- at Wal-Mart's expense?

Jan 3, 2014 at 11:17AM

Wal-Mart Stores (NYSE:WMT) is not one of those companies with a rich heritage stretching back to the early days of retail. The company was started in 1962 in Rogers, Arkansas by Sam Walton with the single objective to offer the lowest prices possible. It has since grown to 11,000 stores in 27 countries.

The question becomes: is Wal-Mart getting too big? Its nearly half a billion in sales is more than the gross national product of many countries. Are companies like Kroger (NYSE:KR) and Costco Wholesale (NASDAQ:COST) waiting in the wings to topple the old giant?

Wal-Mart marches on
There's a new face at the helm of Wal-Mart: Doug McMillion takes over for Mike Duke as president and CEO beginning February 2014. According to Rob Walton, chairman of the board, McMillion possesses "a deep understanding of the economic, social and technological trends shaping our world." McMillion was promoted from the position of president of Wal-Mart's international business.

This leads me to believe that Wal-Mart will continue to focus outside of the United States for growth opportunities and seek to address the challenges of building an international business. The third quarter showed growth in international sales of only 0.2% to $33 billion, while domestic sales increased 2.4% for Wal-Mart and 1.1% for Sam's Club. The company says the slow growth was caused primarily by currency exchange fluctuations. Total revenue reached $114 billion for the quarter.

Operating income from international stores decreased 1.4% from the previous nine months to $4.1 billion. Operating income from domestic stores reached $7 billion for the quarter and $21.6 billion for the nine months, both improved versus the previous year.

Kroger -- more than a grocery store
Kroger is dwarfed by Wal-Mart when you compare the number of stores--Kroger has 2,414 locations compared to Wal-Mart's 11,000. However, Kroger increased its number of stores by 8.8% when it acquired Harris Teeter stores in late 2013.

Kroger's third-quarter sales were $22.5 billion, leading to an operating profit of $534 million -- a decrease from the 2012 third-quarter profit of $596 million. However, on a nine-months basis, the operating profit remains improved versus the previous year.

Kroger's stores carry more than groceries, just like a Wal-Mart, but not every Kroger store offers clothing, sporting goods, and electronics. The good news for Kroger is that it is totally based in the United States, so no pesky currency exchange fluctuations affect its results.

Costco Wholesale buys and sells in bulk
What's different about Costco is you have to pay a membership fee for the privilege of shopping at its warehouse-style stores. The company's strategy is to offer a limited selection of nationally-branded products across a wide variety of merchandise categories at low prices. In other words you might only find three different brands of peanut butter, whereas in a grocery store you'd find 10. Consumable products are often sold by case quantities only.

Costco is the second-largest retailer in the United States based on annual sales of $102.8 billion. Its 648 warehouses are operated primarily in the United States -- 461 locations in all. The company has 87 warehouse stores in Canada, 10 in Taiwan, five in Australia, nine in Korea, 33 in Mexico, 25 in the United Kingdom, and 18 in Japan. That's a presence in only eight countries compared to Wal-Mart's global footprint of 27 countries.

Costco's first-quarter results for 2014 -- for the three months ended Nov. 24, 2013 -- showed a 5.4% increase in sales to approximately $24.5 billion versus the same quarter last year. The cost of merchandise was high at 89.2% of sales. Selling, general, and administrative expenses were $2.5 billion, resulting in operating income of $668 million.

Advertising is limited to announcing new warehouse openings and recruiting new members rather than offering discounts to the general public. Foreign exchange fluctuations also affect Costco, but less than compared to Wal-Mart, since the majority of sales occur in the United States.

Costco has improved its operating income for the last five years, but the rate of improvement has slowed from 16% in 2010 when compared to 2009 to a 10% improvement in 2013 over 2012.

To invest or not to invest
Wall-Mart is on solid footing domestically with steady growth. I have to wonder about its international performance, which is about one-third of the company's sales and stores. The company is closing 50 stores in Brazil and China and is ending its franchise agreement for retail stores in India. This will dilute earnings per share by about $0.10 per share. I'd hold onto any Wal-Mart stock but would decline to invest more until the new CEO has time to have an impact.

Costco is a great concept for those shoppers who have the disposable income to buy a case of peanut butter at a time alongside their weekly grocery and sundry items. For those on a tighter budget, bulk purchases are not as attractive. Taking a look around Phoenix, where I live, Costco is located in more upscale areas than Wal-Mart. The discounts available from bulk purchases certainly encourage members to shop at Costco, but they also may discourage new members to a degree since a membership costs $55.

Kroger is my first choice for investment even though it's No. 3 in size behind both Wal-Mart and Costco. The company has had "40 consecutive quarters of positive identical supermarket sales," says David Dillion, Kroger's CEO, in a press release announcing the third quarter results. Clearly Kroger has positioned itself to give customers the brands they want in quantities they want at the prices they want. 

So who's going to take down Wal-Mart?
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Dee Power has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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