There Are Better Investments in Retail than Wal-Mart Stores

Wal-Mart is too big to grow, but there's one key retailer that could be a long-term buy.

Jun 6, 2014 at 5:30PM

 Wal-Mart (NYSE:WMT) is just another retailer blaming the rough winter. The severe winter weather hurt store traffic, leading to a weaker than expected first quarter. But could it be that Wal-Mart is experiencing other issues beyond the weather? Last quarter, marked the fifth consecutive quarter of same-store-sales decline. In fact, same-store sales have fallen in 14 of the last 20 quarters.

What else is dragging Wal-Mart down?
The low-income consumer has also led weakness to at Wal-Mart. This group has seen limited wage increases and reduced benefits. Brian Sozzi of Belus Capital Advisors believes that investors should be concerned because the company has spent a large amount of money to reduce prices on the types of consumables that should attract its core customer.

He also notes that the company is having trouble generating traffic in its stores in the U.S. during non-holidays. He is not accepting the bad weather as an excuse and says that guidance estimates below consensus for the fifth straight quarter clearly points to problems with operations.

There are some bright spots
There were some positive takeaways from Wal-Mart's recent quarter. Its global e-commerce business grew revenue by 27% year over year and sales were up an impressive 5% at Wal-Mart's Neighborhood Market chain. Wal-Mart operates about 400 of these Neighborhood Markets, compared to over 3,300 Supercenters. The average Neighborhood Market is around one-fifth the size of a Supercenter.

Larger stores are becoming increasingly irrelevant to consumers. This comes as the number of big-ticket purchases (TV and furniture) is on the decline. Meanwhile, its Neighborhood Markets focus largely on fresh groceries and are found in urban locations. Being located close to residential areas makes the stores more convenient for customers unwilling to travel long distances to pick up the everyday necessities.

Thanks to consumers need for convenience, one area that has been performing well is dollar stores. Dollar General (NYSE:DG) is the leading dollar store in the U.S. with over 10,000 locations. It has managed to grow its revenue by close to 10% annually over the last decade. The company's continued roll out of new stores could also put pressure on Wal-Mart sales. Dollar General opened 650 stores last year, and will add another 700 stores this year.

Wal-Mart versus Target
Declining revenue and earnings are the result of changing customer preferences as they use technology to locate low-priced products. Though sales growth is important, Wal-Mart has continued to focus on lower prices in order to attract and retain customers. This has cut into its margins and its profits. Earnings per share in 2013 came in at $4.88 compared to $5.02 per share in 2012. Wal-Mart is, however, a larger international company. Over 40% of its revenue comes from outside the U.S.

By way of contrast, Target (NYSE:TGT) operates only in the U.S. and Canada. The performance of its Canadian operations has been below expectations. The company as a whole is holding up nicely, despite its data breach and sudden announcement of the departure of its CEO. It continues to introduce new store formats (which includes is P-fresh model), beef up its digital business, and is looking to reduce costs by a total of $1 billion by the year 2015.

Wal-Mart trades at a P/E ratio of 13.4 based on next year's earnings estimates. Its dividend yield comes in at 2.5%. Meanwhile, Target's forward P/E ratio is 12.7, and its dividend yield is 3.1%. If we look at Dollar General, shares trade with a forward P/E of 13.6 and does not pay a dividend yield.

Bottom line
Wal-Mart has been experiencing deteriorating traffic and weak same-store sales for years now. Even though Dollar General has been taking market share from the major retailers, it still trades at a higher P/E and does not offer a dividend. Target is cheaper than Wal-Mart and offers a higher dividend yield. For investors looking for a solid play in the retail space, Target may be worth a closer look.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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