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Wal-Mart Surges as Economy Sinks

Posted May 13, 2008

As Wal-Mart goes, so goes the nation—at least a good chunk of it. If you're looking for a glimpse into the mind of the American consumer, keep an eye on its stock price. The retail legend exemplifies the struggles facing shoppers at a time when recession fears and rising prices for food and gasoline are eating into everyone's budget.

Wal-Mart shares have surged right along with our economic anxiety, rising nearly 17 percent since the start of March to above $58 this week, making it one of the Dow's best-performing blue chips for the year. It's a welcome bout of strength following a long, five-year stretch of flaccid trading. Analysts see more upside to come. Last week, Deutsche Bank upped its price target to $65, and analysts at Citigroup followed suit Monday with a $67 target. Second-quarter earnings announced today looked solid. Profits jumped 6.9 percent as earnings climbed to 76 cents a share, a penny ahead of forecasts. Revenue rose 10.3 percent to $93.5 billion from a year ago.

The bottom line, as always, for Wal-Mart is low prices. It's the company's mantra, and it's luring back shoppers more concerned with saving money now than they have been in over a decade. "Wal-Mart has a distinct advantage," according to Joe Feldman, an analyst at retail specialist Telsey Advisory Group. "They're able to get product from a manufacturer into a customer's trunk cheaper than any other retailer."

The timing of the current economic slowdown also offers Wal-Mart a chance to show off the fruits of several years-long plans to grow sales and store traffic. Efforts to boost international sales (now about a quarter of revenue), spruce up stores, and enter new markets—particularly the grocery aisle—are paying off at a time when more shoppers are likely to turn to Wal-Mart on price considerations alone. Analysts say several in-store initiatives—a focus on mid-priced consumer electronics (successful), adding outside brands like Ocean Pacific to apparel (improving), and $4 prescriptions for commonly used drugs (well received)—have made shopping at Wal-Mart more enticing. "Consumer electronics has clearly been their biggest grand slam," says Britt Beemer, who runs America's Research Group, a retail consultancy. "And the supermarket component doubles the number of consumers who shop at Wal-Mart in a given month."

As a result, Wal-Mart may be able to outpace both the economy and its rivals this year. Sustained share price gains will depend on a mix of sales momentum and share repurchases. Deutsche Bank sees sales rising 7 percent this year, projects that the company will end the year with 200 million fewer shares outstanding. That translates to 10 percent earnings growth this year.

On the cost side, inflation is pressuring margins, but analysts say that if anybody can manage a supply chain to offset a record surge in everything from grains to oil, it's Wal-Mart. "Consumers watch TV, and they know milk prices are up. They're expecting to pay a little more," Feldman says. Wal-Mart's operating margins have held in the 5.5-to-6 percent range since 2000, even as inflationary pressures increased.

Second-quarter earnings announced today looked solid. Profits jumped 6.9 percent as earnings climbed to 76 cents a share, a penny ahead of forecasts. Revenue rose 10.3 percent to $93.5 billion from a year ago. So why do Wal-Mart executives still sound glum? Here's Eduardo Castro-Wright, head of Wal-Mart's U.S. stores, after the April sales release: "The economy continues to get tougher, and the 'paycheck cycle' is more pronounced for customers than in past months. As money gets tighter for them toward the end of the month, sales drop more than we have seen in the past."

Again, it's the macro environment that is most worrying to everyone in the retail sector. Combined April and March sales were generally flat, and worries remain that credit card problems and debt maintenance may well be the last step down for the economy in the wake of the housing and credit crises.

At the earnings conference call with analysts today, Wal-Mart chief executive Lee Scott said "uncertainties" remain and that the economy will be the "critical factor in 2008." In the earnings release, the company said second-quarter same-store sales would be flat to up 2 percent. They rose 2.9 percent in the first quarter, excluding fuel.