Wal-Mart Stores (NYSE:WMT) investors have had a tough year. Shares of the retail giant have fallen 15%, sliding as the company's turnaround initiatives have yet to generate momentum.
The company surprised the business world earlier this year when it announced that it would raise wages to at least $9/hour for all employees this April with a subsequent bump to $10/hour next February. It's also doubling down in e-commerce by adding distribution centers, updating its website, and building new capabilities, and it's squeezing suppliers for stocking fees. So far, the market has been unimpressed.
Its two earnings reports this year each prompted a sell-off as the retailer warned on currency headwinds in February, and earnings per share fell 7% in its first quarter report in May.
In the midst of the slide that's taken the stock to near 52-week lows, Wal-Mart just received a surprising vote of confidence from credit-rating service Moody's, which said recently that Wal-Mart's Neighborhood Markets would help widen its lead in the U.S. grocery industry.
More than just a corner store
Wal-Mart's smaller-format Neighborhood Markets have been a bright spot for the company, generating same-store sales growth of 7.9% last quarter. The Neighborhood Markets average a footprint of 42,000 square feet, about a quarter the size of a Supercenter but roughly in line with the size of a typical supermarket. This has given Wal-Mart the flexibility to locate them in more densely packed cities, where it is finding new growth.
The concept isn't a new one for the company, which started it in the 1990s, but Wal-Mart only began expanding it aggressively after the recession. Wal-Mart finished fiscal 2015 with 639 of the smaller stores and expects to add 200-220 more this year. While that would be a significant number for almost any other retailer, it pales in comparison to the 3,400 Supercenters it operates, meaning the effect of the small-format stores on the bottom line is small for now.
Moody's, however, believes the Neighborhood Markets are an undervalued advantage for Wal-Mart, and could be a growth engine for many years. Analyst Charles O'Shea explained:
Walmart's Neighborhood Market melds convenience in terms of location with easier-to-shop stores and a Supercenter-oriented pricing strategy. While traditional supermarkets have upped their game as Supercenters and warehouse clubs such as Costco, Sam's Club and BJ's, and discounters such as Target have become more aggressive, the advantages of the Neighborhood Market concept will be difficult to beat back.
As O'Shea points out, the unique advantages of the Neighborhood Market (price and convenience) are the same ones that led Wal-Mart to dominate retail. However, the small-format stores leverage those advantages in a different market -- cities -- that is still ripe for Wal-Mart, as the rising comps show.
Where we go from here
Moody's believes that the Neighborhood Market expansion will mirror the growth of the Supercenters, meaning we could one day see over 3,000 of the small-format stores across the country.
With the company adding about 200 of the smaller stores per year, that leaves a path of at least 10 strong growth years ahead for the Neighborhood Markets. Wal-Mart already dominates the domestic grocery market with nearly $200 billion in segment sales and the Neighborhood Markets should be able to capture that demand in cities that the Supercenters do not reach.
Moody's sums up its argument as follows:
We believe the stage is set for Walmart to substantially increase its share of the grocery segment via the Neighborhood Market. Walmart's current market-leading position in food has been driven by the expansion of the Supercenter format over the past decade. Our experience with the Supercenters tells us that when opened, they usually take share from every other food retailer in the market early in the game, and though the top one and two retailers eventually do largely recover, weaker operators usually do not.
Though 2015 should continue to be a tough year for Wal-Mart as it invests in e-commerce and absorbs the effects of the stronger dollar, the Neighborhood Market represents a huge potential revenue stream worth $40 billion or more if Moody's prediction is correct. With Wal-Mart's Supercenters having reached maturity, it may be easy to dismiss the company's future prospects. But channels like the Neighborhood Markets and e-commerce should ensure some level of growth in the years ahead.
Jeremy Bowman has no position in any stocks mentioned. The Motley Fool both recommends and 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.