Wal-Mart (WMT, Financial) is widely owned by value managers from Warren Buffett, to Dodge & Cox, to First Eagle, to name a few. The stock has declined to a point where it now trades at only 14 times earnings, so it is bound to attract even more interest from those who previously thought it was cheap at higher prices. So, it seems a good time to try to answer the question, how wide is Wal-Mart’s moat?
It is hard to argue that Wal-Mart has not mastered supply chain efficiency and clearly the company is able to remain solidly profitable while offering low prices across general merchandise and grocery categories. The company also has thousands of enviable locations, and its negotiating leverage with suppliers give Wal-Mart great pricing advantages over some of its rivals. These are all moat enhancers.
I argue, however, that Wal-Mart has effectively lodged itself into an unenviable position of price leadership that will work against the company over time.
I am going to segment a Wal-Mart SuperCenter by department for purposes of illustration. A SuperCenter has two sides, roughly defined as general merchandise and grocery. The general merchandise side has specialty areas within, such as home & garden, toys, electronics, clothing, sporting goods, and housewares. The grocery side has packaged food, house supplies, produce, bakery, deli, and pharmacy.
In general merchandise, the closest natural competitor to Wal-Mart is Target. However, each specialty section also competes with retailers such as Home Depot and Lowes (home & garden), Toys R Us (toys), Best Buy (electronics), Old Navy/Gap/TJ Maxx etc. (clothing), Bed Bath & Beyond (housewares), sporting goods (Dick’s, Cabela’s), even PetSmart in dog and cat food. The grocery side competes with grocers like Safeway and Kroger, but also with Whole Foods, Sunflower, Trader Joes, Walgreen’s, and CVS. Larger communities with SuperCenters are likely to have many, if not all, of these competitors present.
Wal-Mart has pushed price leadership to such an extent that they draw on a significant population of low income shoppers as their core customers, because the pricing message resonates most firmly with those with lower discretionary income. While wealthy people do shop at Wal-Mart, and more frequently, Sam’s Club (who competes head on with formidable Costco), the vast majority of Wal-Mart’s customers fall into the lower to middle classes.
In an era that many predict will have higher food prices (not to mention energy and health care prices), the typical Wal-Mart shopper has less money to shop in the general merchandise half of the store, where margins are higher. This means Wal-Mart must offer these shoppers cheaper discretionary items in the specialty subsections.
As the merchandise offerings have to be catered to the majority of the customers, the specialty sections within SuperCenters will likely be unable to maintain offerings that cater to wealthier customers. While SuperCenters are large stores, they still do not have the square footage to offer the range of TVs Best Buy has, the towels Bed Bath & Beyond has, or the sporting good selection of Dick’s. These limitations are pervasive in practically every specialty area. The space available for each section must appeal to the low end, which almost by definition means that it won’t appeal to most others. This will restrain Wal-Mart’s customer base because anybody with more discretionary spending power wants more selection and higher quality. Another factor is that people with money often do not like to shop (or hang out at all) with those who don’t. This works against Wal-Mart as well.
I believe Wal-Mart will likely continue to suffer in general merchandise areas, but I also want to look at the grocery side of the business.
For packaged goods made by companies like Coke, Pepsi, Procter & Gamble, and General Mills, Wal-Mart continues to offer good selection and prices. However, the moat associated with pass-through distribution of other companies’ branded products names is hard to define. While Wal-Mart has leverage over Procter & Gamble, Procter & Gamble also has leverage over Wal-Mart. Do you think Wal-Mart would be happy if P&G pulled Charmin, Tide, and Gillette from its stores? Wal-Mart really can’t push these name brand suppliers too far. I contend that P&G could dump Wal-Mart and survive, whereas Wal-Mart could absolutely could not dump P&G and survive.
Wal-Mart does offer some quality products from its Great Value house brand, but customers also do not forget things like peanut butter recalls that cause great damage to a brand’s credibility.
Wal-Mart is very vulnerable in produce, where they do not have competitive selection compared to any national food retailer. Wal-Mart also has problems with pharmacy, because many of its locations are too far away from residential areas, and because I believe many people do not want Wal-Mart to handle their pharmacy order for a variety of reasons.
In summary I believe Wal-Mart’s moat is shrinking. Not only are they hemmed in by low price, which constrains the selection they offer and customers in their scope, but their current customers are hemmed in by low purchasing power. Wal-Mart at least acknowledges this now, but I’m not sure what they can really do about it, as most people have made up their minds about Wal-Mart and many people will never set foot inside a Wal-Mart store. The company will likely be around for a very long time, but this doesn’t mean they’ll ever produce great returns again. While the stock has historically low valuation ratios at present, I have no reason to believe Wal-Mart won’t continue to struggle to wring the same level of profitability from its customers.
Mike Rubsam is President of Liberty Steward Capital, LLC (www.libertystewardcapital.com), and has no position in Wal-Mart. Liberty Steward Capital is a Registered Investment Adviser in the State of Colorado .
It is hard to argue that Wal-Mart has not mastered supply chain efficiency and clearly the company is able to remain solidly profitable while offering low prices across general merchandise and grocery categories. The company also has thousands of enviable locations, and its negotiating leverage with suppliers give Wal-Mart great pricing advantages over some of its rivals. These are all moat enhancers.
I argue, however, that Wal-Mart has effectively lodged itself into an unenviable position of price leadership that will work against the company over time.
I am going to segment a Wal-Mart SuperCenter by department for purposes of illustration. A SuperCenter has two sides, roughly defined as general merchandise and grocery. The general merchandise side has specialty areas within, such as home & garden, toys, electronics, clothing, sporting goods, and housewares. The grocery side has packaged food, house supplies, produce, bakery, deli, and pharmacy.
In general merchandise, the closest natural competitor to Wal-Mart is Target. However, each specialty section also competes with retailers such as Home Depot and Lowes (home & garden), Toys R Us (toys), Best Buy (electronics), Old Navy/Gap/TJ Maxx etc. (clothing), Bed Bath & Beyond (housewares), sporting goods (Dick’s, Cabela’s), even PetSmart in dog and cat food. The grocery side competes with grocers like Safeway and Kroger, but also with Whole Foods, Sunflower, Trader Joes, Walgreen’s, and CVS. Larger communities with SuperCenters are likely to have many, if not all, of these competitors present.
Wal-Mart has pushed price leadership to such an extent that they draw on a significant population of low income shoppers as their core customers, because the pricing message resonates most firmly with those with lower discretionary income. While wealthy people do shop at Wal-Mart, and more frequently, Sam’s Club (who competes head on with formidable Costco), the vast majority of Wal-Mart’s customers fall into the lower to middle classes.
In an era that many predict will have higher food prices (not to mention energy and health care prices), the typical Wal-Mart shopper has less money to shop in the general merchandise half of the store, where margins are higher. This means Wal-Mart must offer these shoppers cheaper discretionary items in the specialty subsections.
As the merchandise offerings have to be catered to the majority of the customers, the specialty sections within SuperCenters will likely be unable to maintain offerings that cater to wealthier customers. While SuperCenters are large stores, they still do not have the square footage to offer the range of TVs Best Buy has, the towels Bed Bath & Beyond has, or the sporting good selection of Dick’s. These limitations are pervasive in practically every specialty area. The space available for each section must appeal to the low end, which almost by definition means that it won’t appeal to most others. This will restrain Wal-Mart’s customer base because anybody with more discretionary spending power wants more selection and higher quality. Another factor is that people with money often do not like to shop (or hang out at all) with those who don’t. This works against Wal-Mart as well.
I believe Wal-Mart will likely continue to suffer in general merchandise areas, but I also want to look at the grocery side of the business.
For packaged goods made by companies like Coke, Pepsi, Procter & Gamble, and General Mills, Wal-Mart continues to offer good selection and prices. However, the moat associated with pass-through distribution of other companies’ branded products names is hard to define. While Wal-Mart has leverage over Procter & Gamble, Procter & Gamble also has leverage over Wal-Mart. Do you think Wal-Mart would be happy if P&G pulled Charmin, Tide, and Gillette from its stores? Wal-Mart really can’t push these name brand suppliers too far. I contend that P&G could dump Wal-Mart and survive, whereas Wal-Mart could absolutely could not dump P&G and survive.
Wal-Mart does offer some quality products from its Great Value house brand, but customers also do not forget things like peanut butter recalls that cause great damage to a brand’s credibility.
Wal-Mart is very vulnerable in produce, where they do not have competitive selection compared to any national food retailer. Wal-Mart also has problems with pharmacy, because many of its locations are too far away from residential areas, and because I believe many people do not want Wal-Mart to handle their pharmacy order for a variety of reasons.
In summary I believe Wal-Mart’s moat is shrinking. Not only are they hemmed in by low price, which constrains the selection they offer and customers in their scope, but their current customers are hemmed in by low purchasing power. Wal-Mart at least acknowledges this now, but I’m not sure what they can really do about it, as most people have made up their minds about Wal-Mart and many people will never set foot inside a Wal-Mart store. The company will likely be around for a very long time, but this doesn’t mean they’ll ever produce great returns again. While the stock has historically low valuation ratios at present, I have no reason to believe Wal-Mart won’t continue to struggle to wring the same level of profitability from its customers.
Mike Rubsam is President of Liberty Steward Capital, LLC (www.libertystewardcapital.com), and has no position in Wal-Mart. Liberty Steward Capital is a Registered Investment Adviser in the State of Colorado .
