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Low Prices Aren't Everything for Wal-Mart


It is more important to have the right merchandise at low prices than having the lowest prices.


I was swamped over the last couple of days with the important stuff as my son Jonah turned five. But I am not letting Macke get off that easy. It is Red vs. Jeffmacke. Let's take Macke's points one by one:

Wal-Mart (WMT) 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 has become the biggest retailer in the world due to its operational efficiency. Twenty years ago it was the most efficient retailer out there - period. Today it is still one of the most efficient retailers, BUT the efficiency gap has been narrowing. The technology that drove this company into the stardom of capitalism is available (more or less) off the shelf to other aspiring retailers. However, Wal-Mart's size brings an incredible unmatched buying power and a distribution network that is not available off the shelf to other aspiring retailers and never will be. That is what I call a competitive advantage.

Wal-Mart doesn't have to have THE lowest prices but are definitely among the lowest in jewelry and electronics. It is more important to have the right merchandise at low prices than having the lowest prices. Currently Wal-Mart often has the lowest prices on the wrong merchandise, as the quality of the merchandise doesn't appeal to the more affluent buyers. This will change. But it is my understanding that, in the long run, the strategy has deeper roots than jewelry and electronics; it will translate into merchandising the store for the demographics it serves – having the right product at low prices.

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).

Groceries are a profitable segment for Wal-Mart. At least I did not see any data to suggest otherwise. Groceries stimulate the frequency of visits to Wal-Mart. Here's a true story. My wife sent me to Wal-Mart yesterday to buy olive oil. I bought olive oil and ended up buying other stuff: basketball ring for my son, shorts for $9 that the lucky ones will see me wearing at MIM3, some fancy soap and a lot more spending $78 total. Remember, I was only sent to buy a $5 olive oil. I might have spent even more money if Wal-Mart had the quality stuff that appealed to my middle income consumer taste, but that is in the future.

Target (TGT) 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.

The P/E contraction over last five years has been driven by the fact that in 1999 (at 54 times earnings) and in years that followed, the stock was overpriced the same as many other "religion stocks" of the late 1990s – Microsoft (MSFT), Dell (DELL), Intel (INTC) etc… Despite the gross margin decline by 2% over five years which I'd attribute to higher sales from low margin groceries, Wal-Mart's operating margins have actually risen by half of a percent over the same time frame and earnings more than doubled since 1999. In the longer run it could probably still improve its operating margins as same store sales come with higher margins. Wal-Mart, at least in part, can finance increased maintenance expense by managing its inventory more efficiently. In the last quarter it saved $2 billion by managing their inventories more efficiently.

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Position in WMT, MSFT

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