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Executives

Bill Simon - President and CEO, Wal-Mart U.S.

Analysts

Matt Fassler - Goldman Sachs

Wal-Mart Stores, Inc. (WMT) Goldman Sachs Global Retail Conference September 11, 2013 12:05 PM ET

Matt Fassler - Goldman Sachs

I’m Matt Fassler from Goldman Sachs. And I’m delighted today, here at our lunch, in our second day of our 20th Annual Global Retailing Conference to be able to introduce Bill Simon from Wal-Mart and to moderate a fireside chat after Bill has his prepared remarks. First of all, in terms of Bill, he is the President and CEO of Wal-Mart U.S. which is far and away the biggest driver of revenue and earnings for the company.

From 2007 to 2010, he was the Chief Operating Officer of that business, and prior to that EVP of Professional Services and New Business Development. He joined Wal-Mart seven years ago. Prior to that he had been at Brinker and had a career both in public service and in the corporate world prior to that.

In terms of Wal-Mart, I’m I think the newest analyst on the street covering Wal-Mart, I launched coverage on Monday just in the nick of time for this event, I think as the newbie, Bill will probably have his way with me during the fireside chat so be it.

Copies of our report are in back, but just to give you the highlight of our thought process as we resumed coverage of the big-box discounters our eyes were wide open about the notion of price transparency and the ascendance of eCommerce. And we are very focused on companies that had sustainable edges when it came to price, cost and defensibility versus eCommerce. And our analysis suggested to us that Wal-Mart is actually quite well-positioned along these lines.

We did launch with a buy rating on the stock thinking about the company’s solid foundation, thinking about elements of the story that we think have the potential to shift for the better - I’m sure we will talk about those over time, and thinking about the valuation of the stock.

Bill will kick-off this lunch session with some prepared remarks after which we will engage in a fireside chat and hopefully a conversation with you all. So Bill, to you.

Bill Simon

Thank you, Matt. It’s great to be with everybody here today and welcome to the business and we look forward to working with you.

As we were preparing for the presentation, I was looking at an early draft and I got sort of caught up on this title slide particularly the September 11th part of the title slide in it. I think for all of us, it will be forever difficult to separate the day from the date. And so, mindful of that glad to be here in New York where we can talk to you about our business.

And this is a clearly one of the biggest and best retail conferences of the year and so we wouldn’t want to miss it. But it is a bit difficult for us, we are two weeks out from earnings so there is not much to talk about new from what we haven’t told you and we are two weeks away from our Board meeting where we share our strategic plan with our Board of Directors. And we have been working very hard on that have a great plan and I think I better share it with them though before I share with you. But I will tell you a little bit about where we are going, it is a follow-on from last year and update the key elements of our strategy.

And I guess by definition, good strategies are ownable and differentiatable and I think the way we talk about it is being uniquely Wal-Mart. Before I do that, I do have to show you the forward-looking statement. I do plan on making forward-looking statements. So you can either read this really quickly or refer to the website should you have any questions.

Ownable and differentiatable, a strategy that’s uniquely Wal-Mart, for us it’s what we are building and we will be able to deliver in more detail at the analyst conference that we will have in Bentonville in October. But I want to give you some highlights of where we are going and what that might look like focusing on four key areas.

The first as it always is with us, is about EDLP, everyday low price and everyday low cost combining to deliver what we refer to as a productivity loop. This notion that if we work and manage our expenses we can sell products and drive traffic to the stores and build our business and lower our price again, building, growing around a cycle.

Secondly, I would like to talk about a bit of a shift in strategy that is more multi-format driven and how we optimize the formats that we now have available in the U.S. business. And I’m going to get into some detail about some exciting happenings on our smaller formats today and then more detail in October on those things.

There is a lot of discussion and we have a lot of work in our business on eCommerce broadly and Neil Ashe leads a great team out in San Bruno building and developing eCommerce capabilities that we believe will take us to the next level. We believe at Wal-Mart that the real competitive advantage for us is in the convergence of the digital and physical retail worlds. And I’m going to talk to you a little bit about that today and sort of whet your appetite again for October.

And then finally, I want to talk to you about how we are active in our communities particularly in a couple of areas in opportunity and most recently in some activity around U.S. manufacturing and some initiatives that we have been participating in and particularly an update on the manufacturing summit we held last month in Orlando which was truly, truly a great event.

Let me start with the productivity loop. We believe that we are well-positioned and we continue to execute the strategy that has got us through the first 50 years. First half of this year, top-line was challenged as we reported in our earnings but you already knew that. But the foundation of the business and the strategy itself is sound. We are positioned as sales, we anticipate to recover and improve in the second half, which is what we forecasted. We believe that it will show great rewards to the P&L. P&L is in great shape.

Leverage is something that we found a way to do in many environments across multiple years and good comp times and in a not great comp sales times. Leverage is inherent in our business. We don’t get leverage only from same-stores, we get leverage from the system. We have built probably 600 stores since we built the last distribution center for example. So there is leverage in the distribution system. And we have the ability to continue to drive leverage through our business.

In fact, in the U.S. segment 13 out of the last 14 quarters in the last three going on four fiscal years in a row we have been able to deliver leverage into the business and then have the opportunity to pass the lower prices on to our customers to drive traffic.

We continue to look for opportunities to invest in price. As I said, I think at this conference last year, it is a rational price investment that’s very, very broad and you might ask why then were your gross margins up in the second quarter? There is a lot of reasons but primarily if there is no elasticity, if we invest in price and there is no sales response, we are not going to invest in those categories.

The great example for us is adult beverages, beverage with alcohol. We have been continuing to move prices lower on that and seeing returns in the form of market share gains on that category. Last year, dry grocery, we invested pretty heavily in, this year with some of the pressures on commodity prices and deflationary pressures on the business there hasn’t been as much of a response to that. And so if you take that and combine it with the mix in our business, we have had a pretty good run so far this year on our soft lines, home and apparel businesses which are margin accretive to the business you can get to how we might have not delivered what we thought we would in gross margin focus this year -- for the first half of the year.

But, just to be clear we are going to continue to be aggressive on pricing in the back half, where we see the opportunities, we are going to invest in opportunities to lower the price to drive traffic to our stores.

Increasingly access is becoming more important to customers. And we believe, we have an opportunity today through multiple formats to take our brand closer to the customers and to deliver that Wal-Mart promise about everyday low pricing and access to the products that customers want in multiple formats across the U.S.

As you know, Supercenters still remain our largest vehicle and our best – one of our best return areas for us and we will have continuing steady growth in our Supercenter businesses in both new units and we believe in comp sales increases. The Supercenter really created the stock-up category back in the day and still delivers that one shop-stopping experience better than any format we believe in the marketplace today.

But increasingly, we have the opportunity now with our Neighborhood Market format which is – has done really, really well for us over the last several years. We are at 300 plus units today on our way quite soon in the next 18 months to over 500 units and beyond. And I’m going to talk about them in a little more detail in a moment but before I do, I got to mention how pleased we are with Wal-Mart Express.

The pilot phase of Wal-Mart Express with 20 units in the ground have performed very, very well for us mid-double digit actually comps and can you say mid-double I don't know – that doesn’t -- that even make any sense, really well. They’ve done really well for us.

They’re really kind of a hybrid little store about 10,000 or 12,000 square feet so we tested them as high as 15,000 square feet, they deliver really, really well against three competitive sets. Against the dollar store they have fresh food, pharmacy and gas and perform really, really well and have a pricing advantage. Against drug, they have a significant pricing advantage and they have fresh food and gasoline. And then again, small grocery stores, we have a competitive price advantage.

So it’s really performing well. In addition to that, we’re learning a lot about servicing and constructing small stores that’s actually helped us become more efficient in operating and building the Neighborhood Markets as well and so you’ll hear more about this format and our plans for that as we get into the conference in October.

Some detail on Neighborhood Markets, consistently strong sales, I’m sort of declaring here that I said this is in a couple of small meetings. This is one of the fastest growing formats in retail 60% growth, mid-single digit comps over the last couple of years, doing really well customer experience is great, providing operating leverage to our business as the stores and the comps stores as they come online and returns approaching our Supercenter. We’re very pleased with the format.

As I mentioned just a moment ago, the capital now as we start to roll these out has come down some through scale and some through learnings from our pilot with Wal-Mart Express, lower capital means the ability to hit hurdle rates in more markets. So the prospect of even more Neighborhood Markets exist. We’re pleased with this format and we think the returns are going to be very impressive to our shareholders. You can see a graph about how the acceleration is planned, as I said we’re on pace to have over 500 units in the next 18 months and plans to expand even, even more beyond that.

As I was preparing to talk about eCommerce in this convergence of physical and digital, we pull this Slide together, it sort of struck me that, all of these things on here, we just did in the last 12 months since I presented at this conference last year. And a lot of competitors can do some of these things but I don't know that anybody can do all of them right now. And so think about it from kind of going around the circle, we extended and expanded our marketplace, we launched a new site driven through P&G that was developed internally and fairly short order and it is a great, great search engine and the site experience is improving.

Around to the right, we’ve been focused on distribution and have moved from pilot and beyond to ship from store for fast moving items, if the item comes to your zip code on a 53 foot trailer with the efficiencies and scale of the Wal-Mart distribution system, the last mile and your zip code as you could imagine is much more efficient and quicker to your home. And so now we’re looking at double digits into the – there is a percentage of walmart.com shipments are coming from our stores today.

The in-store experience is also evolving; we launched pay with cash as a program for customers who are interested as we thought who might have some excess issues to the Internet in order to credit. As we found out there is a lot of people who are very interested and not putting their credit card online but still wanted to make an online sales so they buy online. They come into the store, presumably to pay with cash but then use a credit card in the store and that’s been a interesting piece of the business for us as well.

We stood up lockers and locker tests and the customer demand has been – response has been interesting for us and the customers has been very pleased and choose an inclination to repeat purchase there as well. We talk to you about scan and go. We’re rolling that test out in more and more stores, so you can do mobile self-check out on a smartphone in many of our stores and now we have an in-store application for all of our stores that will help you understand, what might be available in that particular store on that particular date and that’s a lot. That’s a lot in a space where there is convergence but there is much, much more.

And if you sort of take these things along with the initiatives from last year that were recent but seen like a long time ago. We launched last year and I think we’ve mentioned at this conference that we’re going to do same day delivery. So, we have the ability to do same day delivery. We have had grocery delivery up in the U.S. for several years now in the Bay Area. We have great learnings from our sister company, Asda in the U.K., who is one of the UK’s leading online grocery.

So we have the capability to do with the customer demand leads us to do in the convergence of these channels and it’s an exciting time and will be an integral part of our strategy when we talk about it in October.

As I said, I think we’re positioned well in the back half of the year. We’ve had some successes in the business on Produce this year. I want to spend just a moment talking about that. Our food and consumable business, the core of our business, we’re going to focus on that in the back half as well, we can be better there and we will be.

Great story for us in home and apparel, I mentioned that earlier, now I want to give you just a little bit of insight into that. I’m going to very quickly mention our holiday programs because we’re underway there and in fact today to our Facebook fans Layaway launched.

Produce has been a focus for us. We methodically gone through the business and tried to improve in categories where we have the opportunity to do so and we will continue to move that forward. Last year, we had a big focus on meat, particularly beef and you saw, we had some great results there. This year, we’ve been focusing on Produce and our Produce business is driven by audit, driven by audit quality and buying to specs and Produce for us in our businesses had by far the best comp, the best comp performance in our food business and in sequential improvement from the first quarter to the second quarter by a 100 basis points.

The audit process has been real interesting for us. We’re not above teaching the test just for the record, the audit is of Produce and we tell the stories. They are going to be audited. And they are audited regularly on Produce. And the idea is, if you teach the test, they ought to get the test right and if you tell them what to study, then they’ll study the right things.

And the audit is real interesting, it’s very simple a third-party comes in unannounced to the store and looks at every item in the Produce area and if they go to the tomato bin and they measure for spec and quality, if three of the tomatoes fail in the bin then the tomatoes fail. And if three items in Produce fail, then the store fails. And since we implemented the program after a ramp up of a couple of weeks, we’re now running in the high to mid-90s in past rate for the store. So the Produce quality through effort and inspection has improved substantially.

We do also audit our competitors, a composite of our competitors and we not surprisingly to us , maybe surprisingly to some of you, we do very well, we beat them pretty significantly, maybe we should tell them that we’re teaching the test as well.

If you combine that with price leadership, nationally over 10% price gap on Produce is an area where we believe there is an opportunity to continue to invest the result you can see there on the bottom chart is improving comp sales in our Produce business and market share gains. We supported that with advertising and you may have seen the national advertising this fresh over campaign much like we did the stake over campaign to communicate to the customer that the product quality is improved and surprising.

The core of our business is food and consumables and we’re focusing on that in the back half and you’ll see us to be more aggressive in this space as we go forward into the back half. From everything, from basic needs to special events, we do really, we need to do really special events particularly have been strength of ours game time you know as the football season ramps up, I was in Dallas on Sunday evening for that game and we have a store literally -- Supercenter, literally right across the street from Cowboy stadium. We put the store there first by the way; they put the stadium and after we put the store there, just want to let everybody know that.

And the store just, I mean, it’s like, it’s like black Friday before a game and they are buying everything, it’s not nail down. It’s like a retailers dream to be in there and I was in there couple of hours before the game. And I was so pleased to see the customer traffic but I was more pleased to see the store manager and every staff member out front helping customers. And those are environments that we really thrive in and you’ll see us focus on the customer, on events as we move forward.

We supported all with marketing, the basket challenge ads for us have been very successful. Those are expanded this year into 60 markets and do well on a couple of fronts for us. The first in a direct price comparison to our competitors. And then, in a business like ours where your brand promise is price. It’s also image advertising for us. It’s not just tactical advertising. When we tell the customer, we have the lowest price in the market that builds our brand equity as well.

In addition, we’re advertising on traditional media channels, everything from Pinterest to Facebook and anywhere the customer might be today.

Home and apparel, I think maybe the story of the year for us. For several years, we’ve had struggled to get traction here but a great new team and a focus on basics initially brought us some traction in the home and apparel and the performance, I’m very, very proud of the way the things should turn around. If you take that strong basic performance and you add some exciting new products in national brands like Ben Hogan and Nivea Athletic wear, we’ve seen that grow. Coming in the third quarter, some more great brands like Calphalon, Russell Athletic and the Russell products in the store starting to come in today and the sell through already even before -- of the official launch is really good, we’re very optimistic about that line. And continued to look for more brands in the coming months.

So if you can take basic -- a basic promise to customers in home and apparel and then deliver a plus to exceed their expectations. We think we have that business model in place and running today and we’re optimistic about that in the back half.

Holiday is here. It’s already, it’s amazing. We launched Layaway earlier, not too long ago, no fee, no joke, ready to go, Layaway and Layaway is a little bigger than it was last year a few more items and we’re starting to see the customer respond to that. But first, this is what we see. I think Monday was associates, today is Facebook fans and Friday is open to the general public and we expect Layaway with a consumer price pressure to be an important outlet for us this year.

We also did something different with our toy offering this year and this has been real interesting. We brought but before the buy, we brought kids together, thousands of kids, young kids, old kids and had them play physically, play with all the toys that might be available that we might assort from this year but then have them choose the items that we thought that they would like and so we have kid chosen products, chosen by kids that are going to be and we went and bought those deep and that’s what we’ll be focusing our business on in the toy season.

This year, the first time in six years, we’ve got new gaming consoles and we’re excited about that. It’s an opportunity to help revitalize our consumer electronic business Xbox1 and PS4, presales have started and they are both doing very, very well. We typically do better in new product launches and so we’re excited about what these things, these two might mean to us. Hopefully, you all have heard yesterday about our or Monday about our cell phone exchange program and so we think that’s good to help drive our business to that combine with Apples new launch. And again, there is new launches we tend to do pretty well.

So, we’re excited about the opportunities for the holiday. We know that the holidays are coming, regardless of what the economy is doing and we’re preparing to serve customers in what will be a time for them to celebrate with their families.

Like to swift gears just for a minute and our business is about people, it’s about serving people and it’s about employing people and for us our company and our business model is about associates and opportunities. Wal-Mart is not a complicated business model. It’s actually quite simple but it’s driven by opportunity. On any given day, we have about at least 15,000 openings and sometimes during the year up to 50,000 openings. So it‘s not hard to get into the company. If you want a job at Wal-Mart, you can find a job at Wal-Mart.

Once you’re in and people join at all different points in their lives whether you’re a teenager, you know looking for a part time job or are you finishing school, whether your senior looking to supplement your income, whether you’re joining us looking for a career. People come in at all different live stages and we provide access points to all different live stages.

Once you are in, I say, its not hard to get in. We have -- we promote about a 160,000 people a year. We have still today in retail one of the largest full time workforces, we’re still the majority full time workforce with the opportunity for 75,000 people a year to transition from part time, so they choose to into full time.

We’ve got a lot of associates to make good solid, middle class income some and that’s represented by 300,000 associates who have spent more than 10 years working for our company. We’re going to defend our jobs, we’re proud of our jobs because they can lead to long term career opportunities, 75% of our managers started is hourly and our entry level managers make over $50,000 a year and store managers average is $170,000 a year. So the opportunity to enter and to advance and to achieve your dreams exists for our associates. And I just feel compelled to mention not every time I get to.

One of the things, you can attend conferences and sometimes they are real interesting but every once in a while you go to one and you sort of feel that there is some magic happening. And if anybody were there and attended this domestic manufacturing summit in Orlando last month, you would have felt it, the turnout was phenomenal. We had a over 1,400 attendees, over 500 suppliers and manufactures attend. 34 states sent their economic development representatives, eight governors thought it was important enough to be there personally and it was all focused around this common goal of rebuilding U.S. manufacturing.

We provide at Wal-Mart the opportunity for people to enter at any point and advance their career to middle class, but one of the big issues in our economy today is the lack of growth opportunities for people to advance in their lifetime. So we all remember the towns that we come from and what’s made there and if you sort of define by who you are and what you make. I grew up near Hartford, Connecticut, where you make (inaudible) and aircraft engines and that sort of defines who we are.

And we are a country that makes things and we have to be a country that makes things. And we are on at a pivotal point in the economy. The metrics and the math is starting to turn in the favor of U.S. manufacturing and many of you’ll have read it, some of you will have written articles about this.

And interesting survey results after the people left the conference 94% of the attendees, the manufactures who were in attendance said that they were already or were planning on pursuing opportunities to bring manufacturing to the U.S. -- opportunities to the U.S. 75% said that either the math already worked or in the next two years would work in their favor. So that they would be able to do that. So this isn’t a patriotic thing, although it is. This is a math thing, this is about the opportunity to bring production closer to consumption and provide an opportunity to help grow middle class jobs.

And we are excited to be involved in it. And personally, we have seen commitments already at this summit. We had six manufactures, make commitments for 1000 jobs over 1000 jobs. And a really interesting categories too, everything from apparel, socks manufactures to electronics, televisions can be made in the U.S. with the right sets of circumstances, with the states and the governors taking active participation and move this thing forward.

We will be participating in the select U.S.A. summit that the Secretary of Commerce will be hosting later this year and the secretary was gracious enough to be at our conference as well and talk about that opportunity.

Thought I would wrap up by showing you an ad. Last year I showed an ad about challenge advertising, this year I thought we would show one about – a little bit about where we think we are headed as a company and some of the things that we believe in.

(Company Commercial)

But, that was a great ad to show on September 11.

Only at Wal-Mart the productivity loop is who we are, it is starting point for this uniquely Wal-Mart strategy. We can deliver low prices to our customers and give them access to our brands in multi format portfolios. And this integration of physical and digital retail is something that we feel like we are uniquely positioned to do. And we are not afraid where we can to take a stand on important issues that will help to move our country forward.

Thank you. As I said I think we are in a great position as we head into the second half to deliver whatever our customers need from us. And with that, ready to take some questions, Matt.

Matt Fassler - Goldman Sachs

Great. Thank you, Bill. And thanks for those great remarks. I’m going to start off by addressing the productivity loop and you mentioned at the outset of the presentation that gross margin in the U.S. have in fact drifted up a bit. So, the metrics on the loop are not I guess fully in sync at this moment.

Can you talk about that the options you have for deepening price cuts, what you might contemplate and talk about how customers are responding to price in general, if you think about the past couple of years and the actions that you have taken?

Bill Simon

Yes, I think it’s a great observation. One of the things I think you noted in your analysis is, food business is inflation driven, has been historically inflation driven. And in dry grocery particularly and for us dry grocery is a much larger component of our food business, then say it is at a traditional grocer be, because of our mix at our Supercenters and because we have still about 600 or 700 discount stores it sell dry grocery products, but don’t sell fresh.

So deflationary pressures on dry grocery impact our business disproportionately than some of our traditional grocery competitors. In a deflationary environment when prices are flat to declining, price is more hard to differentiate. And as I said at this conference last year, we are going to invest in price, but we are not going to invest rationally in price. We look at elasticity and not in the economic definition, pure economist definition of the elasticity. What we mean is, if we can lower our prices and get more dollars sales into our unit sales out of the product will lower our price.

It doesn’t really matter what the price spread is. We could have a 5% price gap, or 25% price gap. If we can do better, serve more customers and generate more revenue by lowering the price we will. But if we can’t, that holds, that we shouldn’t and in some cases in particularly categories like dry grocery, we didn’t see the opportunity to the extent that we thought because of some of the pressures on the business.

Matt Fassler - Goldman Sachs

Okay. I guess second question related to that. With Nielsen now as part of your toolbox presumably you have better visibility, price elasticity and many other things then you had before. One of my observations, when (inaudible) is that you set the clearance price in the market and you probably can be a whole lot smarter about where those price cuts do in fact make a difference as you observe.

Do you see or perceive pursuing any kind of price optimization strategies going forward given the incremental information?

Bill Simon

Yes, I think that’s been a big help for us. It initially helped us, Nielsen helped us identify items. Surprisingly that we didn’t carry, that we are doing pretty well in the market. So we have been taking a more of a micro assortments strategy down to that the geographic and in some cases even the store level and then the follow on to that for us was prices.

We have now visibility across the market and interestingly in our business that gives us an understanding of what velocities, sales velocities or unit velocities are at virtually every price point throughout the marketplace. So, it’s given us a clear opportunity to identify items and categories if there is places for growth.

Matt Fassler - Goldman Sachs

I want to talk for a moment about data. So a lot of the companies at the conference, at a private equity panel we had up on the stage at lunch time yesterday, spoke about customer data and how it’s deployed.

Now you don’t have a traditional loyalty card per se. You do have a lot of data. I know that your Dot Com people are probably very focused on this. Can you talk about how you contemplate accessing and deploying customer data to optimize the running of the business?

Bill Simon

Yes, I’d be happy to. I mean, first, well, we don’t have a traditional loyalty program. We operate a pretty big membership club that is the ultimate in loyalty program. So, we have that set of data that’s available to us. If you take that data and you correlated with traceable tender that exists in the Wal-Mart Stores and then the identified data that comes through walmart.com. And then the trend data that comes through the rest of the business and working with our suppliers.

Our ability to pull data together is unmatched. We have recently stood up couple of years ago a group that designs specifically to understand that and find ways to leverage that in the company. And so while data is a commodity, an asset today. The opportunity for us to use it I think is as good as if not better than others because of the wealth and the breadth.

Loyalty cards only give you kind of a one dimension of data and we get to see it from multiple different sources. We are using it in all kinds of ways today. We are particular and protective about. There are certain parts of data usage that kind of borderline gets in to areas that we would never cross into like the personally attaching data to a customer without their knowledge of it. We are not pursuing anything like that.

But understanding things and this is where gets really interesting, when you start talking about multiple formats. You have a small format store like a Wal-Mart Express and it could sit in the same street as a Dollar Store. And the ability to or sort that for us to assort that the same amount of square footage compared to a competitor in that space is just, I don’t know hundredfold because we have an understanding of what everybody in that zip code buys online through walmart.com, buys in bulk through Sam's Club, buys at the Supercenter down the road and can assort the store 10,000 or 15,000 square foot store. So, that it feels like a much, much bigger store. So magically we know exactly, which SKUs are bought in that particular geography because of our ability to understand the data. We think that gives us a competitive advantage, while others would really struggle to get to.

Matt Fassler - Goldman Sachs

I want to move on and ask a question about online. So, the highest profile online theme today seems to be the notion of food fulfillment via eCommerce and the notion that Amazon is going to roll out its fresh program to more markets.

You are the largest food retailer in the U.S. You also happen to be one of the largest eCommerce players in the U.S. in aggregate. What are your views about the viability of online delivery of food as a big business?

Bill Simon

Well, I mean I think the customer will decide that. We have the capability to do it. We do it in the U.K. today, where the customer demand is there. We have shown we can do it in the U.S. and when the customer demand exists for it, we will be able to get there really quickly. So, it’s not this mystical thing that we can only strive to deliver. We can deliver it today if the demand was there.

The demand is there in pockets particularly dense markets. I mean New York City is a great example probably in the U.S. the best success story. We have been watching Amazon as they rolled it out. The model that they rolled out with $299 membership fee isn’t one that we think is going to be viable for our customers. It may work well for them. We will have to keep an eye on it and watch, but we are prepared. We are prepared to move in that direction should the need arise and the demand be there.

Matt Fassler - Goldman Sachs

Do you think it’s a model, understanding that you have the capability to do it, do you think it can be profitable model in general?

Bill Simon

You know in and of itself it’s hard to give you that answer, but for us is a combined element of what we do today with the forward deployed food with 4,600, 4,700 coming in Sam's Club prepositioned food outlets with its massive scale distribution all the way to the zip code. We believe we can do it profitability, when the time comes.

Matt Fassler - Goldman Sachs

Great. On the online effort more broadly, can you talk about the so called omni-channel efforts those that integrate online and in-store, that your customer is really taking to. What are they asking for and what are they using?

Bill Simon

I probably give you the best example I can give you is the stores, Presidential Towers in Chicago is a Neighborhood Market and so, you know, you would think that our Neighborhood Market business would be purely food. But it’s not actually different points of the year and different times of the year, we see as mix as high as 30% general merchandise in a Neighborhood Market.

And it’s virtually all coming site to store. So, is customers contemplate their purchase decisions in general merchandise, our price is always good. Now access is available and so I think if you talk about it in the context of buying online isn’t always I wanted at home. If you are out here at this conference today and you are going to buy a TV online and you think it might show up at your house and the city and get put somewhere or your home in the suburbs and get laid on your front step or they make you sign for it and everybody is who is ever done that gets that little orange slip or yellow slip stuck to the door.

Oh man, I got to go find the post office or UPS and go figure out how to pick it up. There is opportunities for us to deliver experiences that customer wants and it’s not just by online ship to home. And we are uniquely positioned to be able to do that in a way that nobody else can.

And we think that there will be certain elements, I’m pretty sure gasoline for example will never move online. Don’t know how you can do that. It would be very messy. And so if you could focus your business around traffic and trip drivers and then use eCommerce to wire and connect the rest of the business. We believe that there is an opportunity that can sort of mix our physical asset base and leverage that with the customers increasing demand for digital retail.

Matt Fassler - Goldman Sachs

Fair enough. On the Neighborhood Market, if you could talk about just on the ROI profile of the Neighborhood Market relative to the aggregate U.S. business.

Bill Simon

We have said that the returns were approaching Supercenter returns. There are comfortable enough for us now that they provide an opportunity for us to roll them out.

Matt Fassler - Goldman Sachs

And is that a function of I guess what has let to that. You don’t have the scale presumably that you have from a G&A perspective, whether it’s the right proxy would be the real estate. I would think the metro market is probably a little more expensive. What is enabling you to generate that kind of return profile?

Bill Simon

A couple of things particularly refinement of the model, I think is the first. We started the program, when we first stood them up, there was a lot of Supercenter picturing and a lot of cost that we for example the point-of-sale system that we would put into a Supercenter we would put into a neighborhood market were just fewer register. So, wiring servers just because we were good at that. And so as you refine it and then you learn more about how small stores work, you make some changes.

I think delivery frequencies are another area, where we have been able to improve. Assortment is also have been a place, where I think we had again typically sent in quantities of product that were Supercenter because our supply chain was built around Supercenters and so you get a whole, whole bunch of plums instead of what you need and that means you have less assortment.

So, I think it’s a combination of assortment operating efficiency. And then finally for us I think the breakthrough came operationally, when we had enough stores to create at the market level supervision for Neighborhood Markets separate from Supercenter. So we have a district manager or market manager, whose responsibilities are for that format and not eight Supercenters and two Neighborhood Markets, which you could imagine there, where the attentions would be.

Matt Fassler - Goldman Sachs

Now on the Express format, my understanding is that, one of the gaining factors has been one of the things we are working on is logistics and the challenge of less than truck load quantity as perhaps the optimal way to fulfill based on demand. How do you think the logistics driving Express ultimately get resolved?

Bill Simon

We have got some things that we are working on that we are going to discuss with the Board in a couple of weeks, they are very, very promising in that context, a different way to do distribution that I think could be game changing for those format.

Matt Fassler - Goldman Sachs

I guess we will have to stop there.

Bill Simon

I wish I can tell you. I’m dying to tell you, but I prefer to keep my job.

Matt Fassler - Goldman Sachs

We will enable you to distribute gasoline.

Bill Simon

Okay.

Matt Fassler - Goldman Sachs

The competitive backdrop, I set the clearance price in the market as I said earlier. So one more thing, that you would be the predominant actor. Any changes in the backdrop that you have seen year-to-date as food inflation has been soft and the consumer has been in some sectors subdued as they have been competitive response away from Wal-Mart that has been notable to you?

Bill Simon

You know interestingly enough we do much better in markets that are more competitive. You wouldn’t think so, but we do. Dallas is one of our best markets and is one of the most hyper-competitive retail markets in the U.S. and there is some really good competitors out there, because we compete in every category. We compete with really good competitors in every category.

Kroger’s just doing a great job right now in food for example and then Publix and H-E-B are great too on the food side. Target’s always have been tough and we will continue to be tough. Best Buy is getting better recently. You know you sort of run the gambit, the drug guys are doing really well. Dollar General had a great quarter and is pursuing a good strategy. There is a lot of really good competitors out there, which is I think making us better and makes us understand that what was good enough yesterday or last year isn’t going to be good enough tomorrow or next year and so, we have got to continue to constantly improve ourselves.

There are dynamics that are in play that are really fascinating and interesting to me. As I said earlier, I think the Supercenter created that stock up trip, that one stop shopping trip 20 years ago. And I think frankly, Drug and Dollar are now have taken and created kind of this quick trip feeling in occasion that is fascinating to us which is one of the reasons we are evaluating how to respond to that with smaller store. So this competition in retail in the U.S. is better than it has been and I think better competition will make us a better retailer.

Matt Fassler - Goldman Sachs

Now, as the largest company in the country and certainly the largest retailer, you have your finger on the pulse of the U.S. consumer. And the question that we are asking all of the presenters at this conference is, were your expectation is for the environment in the second half of the year relative to where it was in the second quarter of the year?

Bill Simon

I think we have said that we expect sales to be better in the back half than they were in the first half, so we are planning on that and we are focused on driving that, through initiatives. I think that there is a lot of yanks still in the economy today. We all know what they are, the 2% I think is the affordable (care racket) implemented. I think individual customers, consumers are still trying to understand what that means to them and how they will go forward with that.

The coming January hopefully, a lot of these things will need to be annualized or cleared up in their own mind and so, I think the second half there still be opportunities but as we move into the first part of next year, maybe the eternal optimist but and if I could forecast the economy I mean that fed job might be open pretty sooner and may be I will apply for that.

Matt Fassler - Goldman Sachs

If you think about operating margin and I am asking not for an annual forecast per se, but just directionally for Wal-Mart U.S. Do you think operating margin should be planned on a flat trajectory, a higher trajectory or a lower trajectory given all of the considerations that you have outlined today?

Bill Simon

Well, we are looking for opportunities to invest and invest in price as we see them, we are going to plan on those. And as we see them we are going to take them. So in a perfect world we would have lower gross margin and invest in price in higher comps. And if we believe that there is the opportunity to drive sales through price investment we are going to take them. And we are starting to see those materialize we believe you will see a different -- a little bit different pattern in the back half than you saw in the first half.

Matt Fassler - Goldman Sachs

So I’m going to ask you one question that relates probably a bit more to Wal-Mart corporate than to Wal-Mart U.S., but it is also a question that we are asking universally, so I will put it out there which relates to capital allocation. Investing in the business through CapEx, M&A, buyback dividends we know you have done but any visibility you could give us on what the company's priorities are?

Bill Simon

We focus first on growth, growth in the form of construction and acquisition, if they are available to us. We believe over time over the 50 year history approved to be the best drivers of value for the company. Secondarily, we believe in repurchase, is a way to continue to move things forward as use of cash and dividends.

Matt Fassler - Goldman Sachs

I have more questions but we have a nice audience here, we have roving mics. And I like to give people the opportunity to ask questions and I see -- a hand right back there with the mic, go forward, all the way back.

Question-and-Answer Session

Unidentified Analyst

Do you require a bit of inflation in order to get your comps moving forward, I mean you talked about lack of elasticity response in the grocery side. Do you really -- are you going to need some help from inflation to get positive here in the back half?

Bill Simon

I am sorry, I do not know where you are. So I am just going to talk to the room in general. But, I am not spacing out, I am just looking for you. Require is different than optimal, I guess is the answer. We have always performed better when prices are moving. When they are going up, we have the ability because of our scale and our buying power and just the business model to hold prices longer on the way up.

So if there is inflation in the business more broadly in the business, we will tend to hold our prices and lag the market up and we do well driving comps in that market when there is an opportunity to show prices. The same thing actually happens in situations when the prices are coming down. We have the ability to move more quickly because our turns are faster and we can get through the product more quickly than say some of our competitors with slower turns.

Where we run into trouble historically and you can sort of trace this back is when prices are just kind of not doing much at all. It is hard for us every bit of price motion is self-generated. And the time lag required for – and the dollars required to invest in price to maybe drive a fundamental change in velocity can be challenging.

And so, I think we can drive positive comps in a flat pricing environment when there is changes to price, I think we do better.

Unidentified Analyst

And then the second question I had was just, you have done an amazing job on the cost front, how much more opportunity do you have to leverage your costs on flat comps before you need some comp help in the U.S.?

Bill Simon

We have – if you sort of take a large elements of our expense structure, biggest is cost of goods and there is – that’s not an SG&A lever, clearly but it’s a cost lever. And we believe there is opportunities in the cost of goods always for us to get better.

The second area is logistics and supply chain and we get leverage in supply chain from total sales not just comp sales. And so if you think about it that way, I know the analyst community is focused almost exclusively on comp sales. But you have to take a look every once in a while at total sales because the supply chain is probably one of the biggest lever points, gets leverage from the more boxes they distribute. Not just more boxes to the – more boxes to the same stores. And that goes for our management structure as well. There is leverage there.

And then finally is, productivity at the store and productivity at the store is going to be driven – continued to be driven by technology and technology improvements at the store that make associates jobs faster and easier and more productive in. And that, so those are sort of the combination.

To answer the question, I think we can lever on – continue to lever, I would prefer to lever on positive comps if you want my personal view that’s always better and a better way to go. And but the business doesn’t require - there is some inherent amount of leverage in the business just based on the total growth.

Unidentified Analyst

You briefly touched on some of your better competitors, one person you didn’t mention was Costco. Because I’m sure, you know, they have been gobbling up market share probably more rapidly than anybody mostly from the grocers. You compete against them but it’s less so Sam’s Club than Wal-Marts are from a location point of view, your most direct competitors. They are capturing both share of different trip missions, the big basket trip as well as the small basket trip. Could you talk a little bit about how you are addressing each of those?

Bill Simon

Yes. Terrific competitor, I didn’t mean to leave them out. I just would have been here all day if I would have mentioned all of them and clearly Amazon, there is some really, really nice movement in the convenience sector recently for some guys as well. Costco is tough. I mean Costco is tough. They have built a great business on, an incredible amount of loyalty and I think it’s product driven. I think they have got a great merchandising group. They tend to keep their merchants in place a lot longer and have like a level of expertise and loyalty that consumer loyalty that is enviable by most.

I think we compete with everybody because of the way we set up. And then geographically while it’s natural to assume that Sam’s and Costco compete with each other because of their club format we compete at Wal-Mart on the U.S. side in probably more locations than Sam’s Club does because of the way the geography overlays.

And so as clubs have been more successful in recent years, it’s just another angle for us to have to figure out how to do deal with from a customer perspective.

Fresh initiative for us and the beef initiative for us have both been ways to try to address some of the drivers of – have been – some of the drivers of the club business. Their focus has been - clubs has been on those 4,000 fast moving core SKUs sold in bulk that are primarily food and consumables more recently. There used to be more general merchandise driven and as they moved into food and consumables that’s put more pressure on our business as well.

But it’s not anything that we are not prepared to deal with. We responded with meat last year, we are responding with fresh this year. It’s beneficial to us to have a club business to be able to learn from what’s working there and what’s not working there and we transfer learnings between the businesses as well.

Unidentified Analyst

And on the small basket side, a number of your store managers tell us that they don’t even have the small baskets and it’s difficult, I’m trying to understand what you are trying to do – what you are doing to try to capture that small basket convenience trip?

Bill Simon

I’m sorry. I don’t understand the question.

Unidentified Analyst

Small basket convenience is the fastest growing trip mission.

Bill Simon

Right.

Unidentified Analyst

For items in and out, fewer than six or seven items.

Bill Simon

Right.

Unidentified Analyst

Costco does it, Kroger does it, obviously, a host of people do it. At Supercenters how are you addressing that?

Bill Simon

Yes. It’s tough. Yes. It’s tough. I mean, the Supercenters is a stock up occasion, it’s a commitment. We talk about it that way that the minute you decided to put your blinker on to turn into the Supercenter you got to be committed because it’s going to be – it’s a big store. It’s a big parking lot, it’s always crowded thankfully, always crowded and you got to find what you want at the best possible prices, so assortment and price.

But it doesn’t lend itself naturally to convenience. You can be convenient in the context of one stop shopping, but the abundance of small stores that have sort of popped up over the last five years have made – have given a new dimension to convenience particularly when it comes to those core items and that’s one of the things that we have to figure out in the long run how to deal with.

We deal with it through assortment and price and we deal with through giving the stock-up experience. And then we deal with it through this connectivity of our digital and physical world.

And that’s for me why – we are in a constantly evolving and changing scenario where we’ve got to provide what the customer wants, where they want through whatever format, whether it be digital and eCommerce, club through Sam’s Club, small formats through Neighborhood Market and Express, and then deliver, continue to deliver leverage out of the Supercenters which we have been able to do.

Matt Fassler - Goldman Sachs

We have time for – maybe both of these questions, or one question, this lady here, she could?

Unidentified Analyst

Thank you. Could you talk a bit more about the home and apparel segment, what you’ve done differently to improve the performance there. And the kinds of initiatives you are looking at going forward to further expand and grow in those area?

Bill Simon

I think it starts with talent and the right structure and initiatives to be put in place. I think our senior merchant team on home and apparel is, as good as its ever been in the company’s history. It’s just really, really talented people and industry experts. And I think that’s the starting point.

We changed our comp structure for our merchants about 18 months ago, 12 months ago to incent them to stay in place longer because as we know and we just mentioned it with Costco, more tenure for a merchant more experience lapping yourself of all those things are good, particularly in long lead time categories like home and apparel. You got to be there for a while to understand what’s happening.

If you are buying a cycle and then skedaddling before you get to have to see the result of it, its hard to learn. Second, is the focus on basics, we are a velocity business. We have the traffic at 140 million customers a week to sale velocity. And velocity basics – are the consumables of home and apparel.

It could be towels or it could be candles. But, those are the things that get people in and they are used and they are rebought and they are purchased and their cycle create velocity. And once you have done that on basics you have the permission to move into kind of – we would call fashion basics and apparel but a little bit fancier in home where you can sell a Polo shirt with a stripe on it, as Duncan talks about that’s a difference between basic and fashion basic for us.

And what we have seen is, that you can deliver the volume and velocity of the basics, you get permission to sell fashion basics. We have been able to layer that on with the acquisition of some – up some great national brands in both home and apparel and seen a response in that business.

Unidentified Analyst

Great.

Matt Fassler - Goldman Sachs

Do we have any other questions from the audience? Before we close there has been a room change for the next meeting, Restoration Hardware will be in here. So stay here if you want to see them. Please join me in thanking Bill for his terrific remarks.

Bill Simon

Thank you.

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