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Summary

  • Discount stores face several challenges in the new market dynamic.
  • Wal-Mart and Target are making moves to maintain their top line growth and to quickly convert them to earnings.
  • Both companies are moving in the right direction to return cash to investors, but Wal-Mart looks more a defensive pick.

Discount stores have been facing challenges to generate growth in their top and bottom lines over the past two years. The decline in revenues and earnings is the result of changing market dynamics, as customers are searching for low-priced products by using technology to look for better deals. Therefore, retailers are shifting their focus to the long-term, and are looking for innovative solutions to generate growth and reduce operating costs. Looking at these circumstances, I picked Wal-Mart (NYSE:WMT) to see where it stands in these changing market dynamics, and Target Corp (NYSE:TGT), the closest peer of Wal-Mart, to predict which one is doing best. I will review their business strategies, future prospects and financial situations.

Where Does Wal-Mart Stand?

Wal-Mart operates retail stores in various formats under 69 banners around the world. Wal-Mart has been facing fierce competition with the emergence of private labels over the past five years. This fact is evident from Wal-Mart's growth rates in these years compared to the past. Sales growth is always important for companies if they are going to keep their momentum. Sales growth is the catalyst for everything from profits to cash flows and finally to returns for investors. In order to capture market share, Wal-Mart has been forced to offer lower prices to attract customers, which pushed down its margins and profits. In 2013, its earnings came in at $4.88 per share compared to 2012 when earnings were $5.02 per share.

This trend continued in the first quarter of this year, when Wal-Mart reported a 3.5% decrease in operating earnings. The important news was that its strategic measures are working as the company is generating sales growth. In the past quarter, consolidated sales increased $0.9 billion. It is making big moves to keep strengthening its market share in the challenging market dynamics. Wal-Mart is trying to work more on a customer-centric approach. Wal-Mart seeks to improve its sales growth by strengthening its EDLP (Everyday Low Pricing) focus and offering more innovative merchandise. The company is further looking to support these initiatives by providing enhanced services and a combination of price investments.

Besides all these initiatives, its focus is to win customer loyalty by getting closer to customers and by giving them additional shopping options, and its focus on small format store rollouts and investment in e-commerce are examples of that. Wal-Mart has allocated $13.1 billion towards investments in growth opportunities. It is also focusing on reducing its cost structure with initiatives like EDLP. Amid all this, in the short-term, it will face challenges that will impact its financial performance.

Where Does the Other Player Stand?

Target operates general merchandise discount stores in the United States and Canada. The company is facing hard times and unexpected events, including the recent breach of data debacle and the resignation of its CEO. The company has been losing revenues, and its earnings are down. Results from its Canadian segment are negative, while its U.S. segment is on track. It is working on strategic priorities to strengthen its footprint in this very competitive environment. It made progress in its multichannel, acquired Chef's Catalog, Cooking.com and DermStore that will extend its online assortments. Its launch of Cartwheel resulted in an increase in digital traffic and sales. It introduced formats like CityTarget and smaller formats like Target Express. After experiencing a huge decline in margins, it is also looking to reduce costs by $1 billion by 2015.

I believe that Target's initiative to go deeper into markets will result in growth for the company. Also, its cash generating potential is strong; after making capital investments, its free cash flow is twice what its dividend payments are.

In Conclusion

WMT

TGT

Industry Average

Price/Earnings TTM

15.8

19.1

17.1

Price/Book

3.3

2.3

3.4

Price/Sales TTM

0.5

0.5

0.5

Rev Growth (3 Yr Avg)

4.1

2.5

5.5

Net Income Growth (3 Yr Avg)

-0.8

-12.3

4.9

ROE TTM

21.0

12.0

21.5

Debt/Equity

0.6

0.8

0.6

Source: Morningstar.com

Target has outperformed Wal-Mart in terms of dividend growth and price appreciation. Due to recent controversies and last year's poor financial performance, its stock experienced a selloff, and it lost about 19.7% of its value over the last 52 weeks. The selloff has given dividend investors an opportunity to consider buying some Target shares, as it has the potential to sustain its dividend growth. Though its Canadian segment is far below than expectation, the good news is that its recent investments and growth strategies, particularly in Canada, are working. In the first quarter, the company's sales from Canada are higher than the past year quarter. Changes at top management levels will not hamstring the implementation of strategic objectives, and we hope for the best results.

Wal-Mart, on the other hand, is generating steady growth all around the world. The company is focused on its objectives, using multiple channels for growth. It is looking to lower costs and to convert higher revenues into profits. It is important for Wal-Mart to lower costs in order to increase margins and profits. Its dividend growth was low in the past year, and I am not expecting major growth this year. But it is a good stock with limited risk for defensive investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Is Wal-Mart A Better Dividend Pick Than Target?