Wal-Mart (WMT 3.23%) is having a rough year in 2015: Shares of the retail juggernaut are down by almost 30% in the last 12 months on the back of disappointing sales performance in a tremendously challenging competitive landscape. On the other hand, the company seems to be taking steps in the right direction, and Wal-Mart stock looks attractively valued compared to competitors such as Costco (COST 0.23%) and Target (TGT 0.93%). Will 2016 be a big turnaround year for investors in Wal-Mart?
A brave new Wal-Mart
Discount retail is a remarkably aggressive business, and most industry players are willing to sell their products at big pricing discounts in order to protect market share in a savage competitive landscape. Making things worse, the rise of e-commerce is inflicting a lot of damage on traditional brick-and-mortar retailers, so most retailers are facing major difficulties when trying to generate sales growth.
Wal-Mart is no exception to the rule; the company has reported lackluster sales performance over the last several quarters. For the quarter ended on Oct. 31 Wal-Mart registered a 0.5% decline in total revenue. This was mostly due to currency headwinds, though, since sales in constant-currency grew 2.8% year over year. Comparable sales for Wal-Mart in the U.S. grew 1.5% on the back of a 1.7% increase in traffic during the period.
Nevertheless, there are some bright spots to consider. Wal-Mart is having considerable success with its neighborhood store format, comparable sales in this division grew by a vigorous 8% last quarter, reaching 19 consecutive quarters with positive growth in comparable sales for this segment. Gross merchandise value in e-commerce grew 10% year over year, and the company has managed to sustain comparable sales in the U.S. on positive ground for five consecutive quarters.
Perhaps more important, Wal-Mart is increasing its investments in people and technology to jump-start growth. This will clearly hurt profit margins; management calculates that increased investments will reduce operating profit by $1.5 billion in fiscal 2017. However, you sometimes need to forego short-term profits if you want to accelerate growth, and management is making a courageous decision by investing for future growth at the expense of current earnings.
The company believes that it can sustain sales growth in the range of 3% to 4% over the coming three years, this would amount to $45 to $60 billion in additional revenue. This kind of growth is nothing to write home about, but it would still be a major victory for Wal-Mart to prove that it can generate consistent sales figures over time.
Wal-Mart stock looks like a bargain
Wal-Mart is going through a challenging period, but that's old news at this stage. Most of the company's challenges are well-known and reflected in current stock prices. When comparing valuation ratios for Wal-Mart against competitors like Costco and Target, Wal-Mart is materially cheaper in terms of price-to-earnings ratios, price-to-sales, and dividend yield.
Costco is doing much better than Wal-Mart. The company is the leading player in the warehouse retail business model, and it has a more affluent customer base. Costco reported a 6% increase in constant currency revenue excluding gasoline price deflation during the 12-week period ended on Nov. 22, proving that Costco is clearly outperforming Wal-Mart by a considerable margin.
Target's financial performance is much more modest in comparison to the vigorous figures reported by Costco. Target announced a 1.9% increase in comparable-store sales during the quarter ended on Oct. 31, driven mostly by a 1.4% jump in traffic during the period. The figure was near the high end of the company's guidance, but Target is still delivering quite a lackluster performance on the top line.
Smart investment decisions are not just about picking the companies which are doing better than others. Financial performance and fundamental quality are undeniably very important, but valuation can play a big role in determining the returns available to investors. Wal-Mart is priced at dirt-cheap levels, and the company seems to be making progress in some important areas. If management can jump-start revenue growth in the middle term, 2016 could be a big positive year for investors in Wal-Mart stock.