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Discounters of the Damned


"Wal-Mart vs. Target. Macke vs. Red. Game on, baby!"

Target (TGT) is getting pole-axed for 5% today after coming in a penny light on their fiscal first Q. Sales were strong, margins weren't great and an uncomfortable amount of the growth came from the credit card operation. Target does an OK job on credit, as retailers go, but they aren't a financial. Retail investors like earnings growth from retail, so when credit-related earnings are growing over 50% year over year while the rest of the joint struggles to clear 10% it's not a "good" thing, stock wise.

Another fly in a report which seems more fly than ointment was the 15.3% increase in "Selling, general and administrative expenses" or SG&A. SG&A is a sort of catch-all line which includes everything from salaries to ads to store maintenence.

Which brings us to Minyanville's Prof. Red "Klitscho" Katsenelson and his nakedly Macke-Baitin' agitation on today's Buzz as well as last week's Financial Times.

Red argues that Wal-Mart (WMT) is making a credible run at Target's affluent customer base by upgrading Wal-Mart stores and inventory. He points to Wal-Mart's stated intent to remodel 1,800 stores as evidence that Wal-Mart stores will no longer be aesthetic ringers for your average Kmart (SHLD). With Wal-Mart's world-best distribution system, Red concludes, Wal-Mart will rise again to be a creeping menace to the rest of the retail world.

Skipping the standard pre-amble about the chance that "Red is right about Wal-Mart's comeback," my "expression of appreciation for the intellectual debate on display by his taking the other side of my ideas" and a stock statement of "humility in a world of unknowns" here are two reasons Macke is Right (and Red is Wrong) about Wal-Mart.

1. Competing on price is a losing strategy.

Wal-Mart has the most cost-efficient distribution in all of retail but, in the day of Internet shopping and retail store saturation, it doesn't matter. Wal-Mart will never be able to bring in a "Lowest Price" model to electronics or jewelry, to name two potential growth areas the company has discussed. Price sensitive shoppers can find better goods for lower prices on the Internet, as is the normal shopping practice for high ticket goods today.

Wal-Mart can bring a cost advantage to grinding segments like grocery but the stakes are much lower, as evidenced by Wal-Mart's declining bottom line despite relatively strong growth in food sales. And regardless of price advantages, Wal-Mart is and will remain at a store-box disadvantage vs. well-run grocers (like Safeway (SWY) which I remain long).

2. For Wal-Mart to do more than a token revamp of their stores SG&A is going to have to go higher.

Target is having a hard time controlling their SG&A and well-maintained stores are TGT's lifeblood. Wal-Mart is going to have to do more than a one-time revamp of their chain, they need to start pouring more maintenance money in as well. With a declining operating margin having driven WMT's stock P/E contraction for the last 5-plus-years, a ramp in expenses is likely to be troubling to the Street.

And what will it look like if Wal-Mart tries to nickel and dime the remodels, slapping a coat of paint on some stores then going back to business as usual?

Let's put it this way: those atrocious KMart stores are the product of two "chain-wide remodels" in the last decade.

Wal-Mart reports tomorrow morning. Keep an eye on margins, both gross and as a function of their SG&A. I think the strong sales have come through gains in lower-margin product areas; leading to a bottom line that either misses or has considerable "squish" in terms of some of the accounting. Target has a lot more margin to play with than Wal-Mart and, again, the stock is getting battered today for a hike in spending. What will the Street do to Wal-Mart?

One quarter doesn't make a war but tomorrow morning is battle one in Prof Red's defense of Wal-Mart.
Position in SWY

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