With macroeconomic issues like higher interest rates and stubborn inflation pinching consumers' ability to spend, retailers are bracing for tougher times ahead. Two of the best-known companies in the industry, Walmart (WMT 1.32%) and Target (TGT -0.70%), are preparing for a notable slowdown, as growth expectations for the current fiscal year are muted.
So, which of these top retail stocks is the better buy? Is it the 800-pound gorilla that is Walmart, or the much smaller but still formidable Target? It's time to go shopping for the right clues to find out.
The case for Walmart
One of the most obvious reasons one would consider owning Walmart shares, especially right now, is due to the unfavorable macroeconomic backdrop. With its intense focus on providing low prices, Walmart's value proposition is put on full display when inflation is running hot and customers are looking to save money. Even more impressive for shareholders, Walmart posted solid gains during the Great Recession, as well as throughout the coronavirus pandemic. This is a durable business, one that was able to post healthy U.S. same-store sales growth of 6.6% last fiscal year.
With fiscal 2023 revenue of $611.3 billion, making this the world's biggest retailer, Walmart is able to take advantage of its negotiating leverage with suppliers. For many of these suppliers, having access to Walmart's distribution capabilities, with its 10,500 stores, is a make-or-break partnership, one that cannot be lost. That means Walmart will always have the upper hand when it comes to obtaining favorable pricing terms, savings that are passed on to customers.
Launched in late 2020, another important development that can work wonders for the company is its subscription offering, called Walmart+. This gives members free delivery on items from their nearest Walmart location, as well as fuel savings and other perks. While Walmart is nowhere near the level of adoption as Amazon Prime, it's not difficult to imagine that this service will do well to drive loyalty, given how massive Walmart's reach is.
The case for Target
Starting from a much smaller base means that Target has simply posted better growth. Over the past 10 fiscal years, Target's average annual revenue gain of 4.3% is higher than Walmart's 2.7% average increase. As of Feb. 28, Target counted nearly 2,000 stores nationwide, a physical footprint one-fifth the size of Walmart. What's more, Walmart's average operating margin in the past decade of 4.5% also lags Target's 6.3%. The latter clearly has had a better financial profile.
While many investors have focused on the decline of brick-and-mortar retail in recent years, the best strategy for affected companies has been to invest in their omnichannel capabilities. Target acquired delivery platform Shipt in December 2017, and it has helped the company's online presence. In fiscal 2022, digital sales accounted for 20.8% of overall revenue. Since digital channels are generally higher margin, as more business shifts here over time, it can support greater profitability for Target.
"Since 2019, our store base has only grown slightly, but total sales grew nearly 40% in that time frame, our digital business nearly tripled in size, and our sales per square foot increased by 37%," CEO Brian Cornell said on the Q4 2022 earnings call, highlighting the productivity gains.
Because its competitive positioning is entrenched in the retail sector, Target is a consistently and sustainably profitable corporation. That allows the business to reward its shareholders. Target has paid out a quarterly dividend since its initial public offering in 1967. It's hard to beat that, particularly if you're an income investor. The company's current dividend yield is 2.7%, higher than Walmart's 1.6%.
Valuation as the deciding factor
It's difficult to pick which company is the better buy today. Walmart is built to shine in a recessionary scenario, so that makes it a safer play in a time like now. On the other hand, because of its much smaller size and bigger e-commerce push, Target's growth is poised to be better than Walmart's as we look ahead.
The deciding factor, then, must be the valuation. As of this writing, Walmart's stock traded at a forward price-to-earnings (P/E) ratio of 23, compared to Target's 18. And despite being down 28% over the past year, which has helped make the valuation more attractive, Target's shares have also performed much better than Walmart's over the past three-, five-, and 10-year periods. Maybe there's more of that in store over the next few years.
For investors who are looking to go shopping for a steady retail stock, Target might be the one you need to add to your cart.
