The price war among U.S. retailers has intensified so much that every major company is announcing price cuts at an alarming frequency.
Amazon (AMZN, Financial) slashed prices at Whole Foods as much as 43% as soon the acquisition was complete; Walmart (WMT, Financial) has always been focused on the "as cheap as possible" creed; and Kroger (KR, Financial) has been cutting prices as well. But it’s not just the grocers trying to outdo each other by slashing prices as Target (TGT, Financial) has now joined the price-cutting game.
In a recent blog post dated Sept. 8, Target wrote that it had cut prices on “thousands of items, from cereal and paper towels to baby formula, razors, bath tissue and more,” making it amply clear that it wants to woo consumers back into its stores with the discounting approach. But has such an approach worked in the recent past?
It’s obviously a great time for customers, as they are spoiled for choice, and Walmart, Amazon, Target, Kroger and nearly all the retailers are left with no choice but to slash prices in a bid to outdo each other.
But the problem for investors is that such stiff competition in an already margin-constrained industry is going to eat further into their companies’ profits. In some cases, they’re going to see their sales drop along with shrinking margins.
The market knows this and has been on a correction course in the retail segment, adjusting valuations sharply for all the big retailers. Costco (COST, Financial) is up by nearly 6% since the start of the year, Walmart by 15% and Home Depot (HD, Financial) by 19% while Target and Kroger declined by 17% and 37%.
Clearly, it’s a mixed bag, and not all retailers suffered at the hands of Mr. Market. The market seems to be fairly neutral with Costco and a bit upbeat about Walmart’s and Home Depot’s fortunes while it is clearly not impressed with Target and Kroger.
A closer look also reveals that the stock price movement is closely aligned with the way comparable-store sales have moved in the last year for these companies.
Costco’s comparable-store sales in the U.S. have increased by 4.3% in the last 52 weeks; Walmart has been on a roll, posting same-store sales increases for 12 quarters in a row; Home Depot reported U.S. comps growth of 6.6% during the recent quarter and expects 2017 full-year comparable-store sales to hit 5.5%.
In comparison, Target’s comps declined by 1.3% in the first quarter of the current fiscal before recovering to positive 1.3% in the second quarter. The notable aspect of Target’s recovery during the second quarter is that traffic increased by 2.1% but pushed the company up by only 1.3%, which means Target slashed prices by nearly 80 basis points during the period.
Kroger was no different as the company reported 0.2% identical same-store sales excluding fuel for the first half of the year and expects full-year numbers to be in the 0.5% to 1% range. The low sales growth numbers clearly show that the company is struggling to get traffic, which means there is a lot more pressure on the pricing front –Â and its margins.
What the market has done in the last year is reward companies that were able to pass on price increases –Â essentially, companies that were able to show positive comps growth with a combination of traffic and ticket increase. Walmart, Costco and Home Depot did that and saw their valuations move up. Companies like Target and Kroger, on the other hand, improved their comparable-store sales numbers with increased traffic but falling ticket prices so they didn’t merit the same treatment.
I expect the trend to continue for the next few quarters as the market figures out on which retailers to make bets and which to avoid. If you have invested in the retail segment, it's time to remain cautious while also taking advantage of opportunities that come your way.
Target and Kroger will continue to be under pressure until their traffic and ticket both start to grow meaningfully, but Costco, Walmart and Home Depot should be on the investors’ watch list. There will be plenty of buying opportunities over the next few quarters as these stocks move up and down with news bites.
Disclosure: I have no positions in the stocks mentioned above and no intention to initiate a position in the next 72 hours.
