For years Wal-Mart Stores (NYSE:WMT) has moved large supercenters into small towns, replacing local commerce by providing lower prices. The company calls it "investing in price" and it's been an extremely profitable business model based on economies of scale; but it's time for an update.
The truth is most large-box retailers are suffering from declines in same-store sales. My theory is that large-box stores are a drag on return on assets; they don't provide the same advantages in scale as they have in the past and require high traffic to break even. Small-box retailers, on the other hand, have a lower breakeven. They have the same access to low-price supply chains, can move inventory faster, and respond to changes in demand faster.
New CEO, new ways
C. Douglas McMillon grew up only four hours from Bentonville, Ark., the location of Wal-Mart headquarters. In 1984, McMillon began his career with Wal-Mart as a summer associate in a distribution center, and on Nov. 25 he was promoted to succeed Mike Duke as CEO; he assumed that role on Feb. 1.
I listened to the Feb. 20 conference call expecting to hear more talk of promotions and better customer service.
"Comp sales improvement is a key priority," McMillon said, "and we'll use a combination of price investment and enhanced service to accomplish this."
I'm glad comp sales is a key focus area, but it's the same strategy other large-box retailers are employing to combat lower traffic. It leads to pricing wars -- Canada's a good example of how this scenario plays out.
Thankfully, McMillon and his team have another idea that will take Wal-Mart into a period of growth: leveraging the current base of supercenters.
The case for smaller stores
Dollar General (NYSE:DG) is one of the only discount-retail operations that thrived in 2013, as sales increased 10.5% in the third quarter to approximately $4.4 billion. With more than 11,061 stores, the company is actually larger by store count than Wal-Mart, which has only 4,203 stores in the US. Same-store sales increased 4.4%, slightly below the 5% comp growth rate Wal-Mart announced for its smaller store formats in the fourth quarter but much higher than the overall comp-store sales rate of -0.4%.
The primary difference between Dollar General and Wal-Mart is not scale; it's store size, and Wal-Mart has figured out a subtle way to grow same-store sales again without cannibalizing its own revenue.
The following chart was published by Wal-Mart and shows the breakdown of store formats as of Jan. 31.
By year-end, Wal-Mart plans to have 270 to 300 more small-store formats, double its original commitment made in October.
We've been working to improve our speed to market and lower capital costs to allow us to move more aggressively.
It's not just a move to small stores that will transform the business model, it's the use of supercenters as distribution/supply centers. Wal-Mart is leveraging its current base of supercenters to enhance fulfillment. Bill Simon, Wal-Mart U.S. president and CEO, had this to say:
Our small store expansion will also strengthen our market share and create greater efficiencies in our supply chain through a tethered approach that uses supercenters as a supply chain base, links our resources and provides a unique and connected customer experience.
The primary risk associated with small-store expansion is cannibalization. In its 2013 10-K filing, Wal-Mart estimated that new stores had a negative 0.7% impact on existing units; but supercenters are generally located in large lots, and smaller-store formats give the company more flexibility in big cities with space constraints. These stores are one-tenth the size of supercenters and less likely to cannibalize traffic.
Making the decision to open more smaller-store formats has several benefits:
- it increases same-store sales
- it increases store growth without cannibalizing current market share
- it may help to transform the perception of Wal-Mart from corporate supercenter to community corner store.
It takes good leadership to identify problem areas, align resources into focus, and pull the trigger, especially under such intense scrutiny. Yes, plans to build more small stores were already announced in October, but the new CEO had the nerve to push for more. Indeed, McMillon's legacy may be these smaller stores. My only criticism is that he didn't request more.
Other initiatives, such as investments in Canada, e-commerce, and compliance/quality control will also help the company, but an investment in smaller-store formats could be the beginning of a new growth channel in the U.S.
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