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Wal-Mart (NYSE:WMT), which competes with other brick and mortar retailers like Costco (NASDAQ:COST), Target (NYSE:TGT) and Best Buy (NYSE:BBY) as well as online retailers like Amazon (NASDAQ:AMZN), is pushing for online sales ahead of the holiday season.

Given the anemic economic recovery and uncertainty surrounding consumer spending, Wal-Mart’s push may not come as a surprise. In difficult times in the past, the retailer has aggressively used its popular rollbacks or “every day low prices” strategy to squeeze competition and gain market share using its scale as an advantage. This holiday season, it is offering free shipping, which will pressure its traditional competitors and could be seen as a shot across the bow at online retailer Amazon.

We explore the upside and downside potential of Wal-Mart’s strategy and how it might impact our current price estimate of $65.42, which is about 20% ahead of the current market price.

Higher Consumer Spending

In order to capitalize on the retail buzz surrounding Black Friday next week, the retailer announced recently that it will offer free shipping on nearly 60,000 holiday items until December 20th in the US.

As reported by Bloomberg, October 2010 economic data suggest that the US economy could see a relatively strong 4th quarter compared to previous expectations, and employment in the US improved for the first time in five months. According to Nigel Gault, Chief US economist at IHS Global Insight in Lexington, Massachusetts, recent payroll gains will provide a boost to consumer spending in the fourth quarter.

An improving macro backdrop coupled with Wal-Mart’s promotions could lead to higher sales and an improvement in the company’s revenue per square foot figure.

Below you can see how Wal-Mart’s stock is impacted by a change in revenue per square foot for its US business. By our estimates, a gradual 5% improvement in revenue per square foot by 2016 adds 2.5% to our price estimate.

No Minimum Purchase Could Impact Margins

Wal-Mart may improve its sales by offering free shipping, but if there is no minimum purchase amount, small value purchases could lead to the retailer bearing higher expenses relative to sales.

If we assume that Wal-Mart’s shipping charges are comparable to those for Amazon, minimum shipment costs could amount to somewhere around $3 for small items and much higher for expensive and larger items[1].

Considering that Wal-Mart is offering free shipping for all items, the shipping costs could be a large part of revenues if people take advantage and a buy lot of small value items. In the press release the company claims that shoppers will save $25 million this holiday season[2].

While this offer only lasts a month, it seems unlikely that it will impact the company in near term. However, if consumers start to move from stores to online shopping and expect some form of free shipping, we could see some gross margin pressure in the medium term. We note that Amazon gross margins of about 24% are below Wal-Mart’s[3].

If we assume that Wal-Mart’s gross margins were 1 percentage point lower through 2016, this takes off about 2.5% from our price estimate.

While we’re not sure yet if the impact will benefit shareholders longer term, we suspect that the company is not planning on giving shipping away for free simply in the spirit of the holidays.

Notes:

  1. Estimated from shipping costs mentioned on Amazon’s website
  2. Walmart Offers Free Shipping Online
  3. From recent 10-Q filing

Disclosure: No position

Source: Does Wal-Mart’s Online Push Make Sense?