The PEG+Y ratio compares a company’s yield and expected growth to their projected P/E ratio. The higher the number the better, and Wal-Mart scores a 0.80. By comparison, Target Corporation (NYSE:TGT) sells for almost the same P/E ratio, but has a higher expected growth rate, which gives the company a PEG+Y of 0.87. Costco seems expensive considering its lower yield and only slightly higher growth rate, and it scores a 0.60. Amazon’s stratospheric P/E ratio dwarfs the company’s expected growth and gives the stock a PEG+Y of just 0.19.
It’s one thing to like Wal-Mart’s yield and value, it’s another thing for a company with over $400 billion in annual sales to continue producing good results. One of the biggest opportunities for Wal-Mart is unfortunately hurting the company’s margins.
Wal-Mart is trying to take market share in the grocery business, and for the last two quarters the company reports they are succeeding. This industry is worth billions and can support many large players. The problem is, Wal-Mart’s gross margin is being compressed because of these sales.
In the most recent quarter, Wal-Mart’s gross margin was 24.66%. While this is better than Costco’s gross margin of just 12.64%, it falls behind Amazon at 26.56% and lags Target Corporation (NYSE:TGT)’s margin of 30.70%. However, Wal-Mart’s over 4,000 domestic locations, and the fact that they always have low prices, make the company a tough competitor in this space.
It’s Not Enough
There is just one huge problem with trying to take market share in the grocery business. As Wal-Mart steals market share, their margins theoretically fall. If this trend continues, the company’s sales will appear weak until their margins stabilize.
With domestic sales increasing just 0.3% and international sales up just 2.9%, the company’s revenue growth leaves something to be desired. What Wal-Mart needs to do is borrow heavily from their competitors’ business ideas. First, Wal-Mart needs to scale back the size of their CD, DVD, and Blu-ray selling space. To be blunt, the move toward digital entertainment is killing the value of these physical formats, and other retailers like Best Buy Co., Inc. (NYSE:BBY) are suffering because of this transition too. Best Buy Co., Inc. (NYSE:BBY) is beginning to move floor space toward better selling items, and Wal-Mart needs to make this choice as well.
Second, Wal-Mart needs to put more focus on its online sales. Target’s Redcard offers shoppers free shipping and a 5% discount. Costco’s warehouse pricing can beat Wal-Mart at its own game, and Costco’s partnerships offer members discounts on everything from brokerage accounts to auto purchases. Amazon is getting smarter by asking about purchases, sending e-mails to suggest items from categories customers have already looked at, and making suggestions. Wal-Mart offers a decent online selection, but that’s about it.
Last but not least, Wal-Mart needs focus on parts of their store that can offset the pressure of increased grocery sales. The company’s aisles are often crowded and sometimes disorganized. Wal-Mart has increased their clothing and home goods options, but they need to look to Target’s example and get a known designer to offer items exclusive to their stores. Higher margin clothing or home goods are how Target maintains a better margin despite the fact that over 75% of Target stores offer groceries.
Wal-Mart is a great company with huge sales and bargaining power, the company just needs to experiment with a few changes to regain their seemingly lost sales momentum. The stock offers a good value already, but imagine what it would be worth if the company returned to double-digit earnings growth. Wal-Mart must adapt and change with the times, or this 800lb gorilla will be looking up at another company sitting on its throne.
The article What Should This 800lb Gorilla Do? originally appeared on Fool.com.
Chad Henage owns shares of Target. The Motley Fool recommends Amazon.com and Costco Wholesale (NASDAQ:COST). The Motley Fool owns shares of Amazon.com and Costco Wholesale. Chad is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.