On August 25, although Fed chair Jerome Powell’s message at Jackson Hole in Wyoming was not as brief as last year’s, it was still equally unambiguous. 2% still remains the non-negotiable target for the inflation rate, and the Central Bank is prepared to raise policy rates further if required and hold them higher for longer until it is confident of sustained price stability.

The 12-month PCE has declined to 3% as of July from its peak of 7% in June 2022 due to a significant unwinding of the demand-supply imbalance. However, the core PCE, which excludes volatile food and energy prices and includes inflation for goods, housing services, and all other services, came in at 4.3% in July, indicating significantly more ground left to cover through monetary policy tightening.

In such a scenario, we compare the performance and prospects of three big-box retailers, Walmart Inc. (WMT), Costco Wholesale Corporation (COST), and Target Corporation (TGT).

U.S. domestic consumption has been on a roller coaster ride over the past three years. People have gone from not being free enough to spend practically free money to spending like there’s no tomorrow.

Meanwhile, with the pandemic firmly in the rear-view mirror, Americans have been now going above and beyond to compensate for the years spent indoors trying to substitute real experiences with virtual ones.

However, with the stash of stimulus cash fast dwindling, stressed American consumers have been forced to go bargain hunting to squeeze out the maximum possible value from money for bare essentials so that more of it can be set aside in favor of outdoor experiences instead of manufactured goods.

Consequently, even the ones from the higher income segments have been inclined to balance splurging on services with shopping by trading down to budget-friendly retailers.

However, not budget retailers are created equal. WMT, the largest grocer in the world, with more than 60% of its revenue in the U.S. from the grocery segment, saw strength across categories such as grocery, health, and wellness.

Founder Sam Walton built the company on a no-frills approach to make groceries and other products more affordable. True to the spirit, the retail giant is known for its mantra of “everyday low prices,” and its focus on value has become synonymous with its name.

Hence, amid the post-pandemic inflation, WMT has been relatively immune to the seismic shifts in the consumption ecosystem. Moreover, its image has helped it retain its existing customer base and gain new patrons.

Hence, according to GlobalData, while WMT’s average household income is about $62,000, for the past two quarters, the company said about 75% of its market share gains in groceries have come from households with an annual income of more than $100,000 a year.

Moving up the value chain, COST, which caters to shoppers with an average household income of about $79,000, used to derive 21% of its sales from unplanned purchases before the pandemic compared to WMT’s 12%. Hence, the budget retailer, which has converted its 1900+ stores into mini-malls offering a range of “cheap chic” items, derived only about 20% of its sales from groceries and other essentials.

As a result, amid post-pandemic inflation, TGT’s comparable sales rose just 2.7% compared to 8.2% year-over-year for WMT. WMT’s online sales in the U.S. rose in the three-month period ending June 30, while that of TGT fell.

Further up the value chain, warehouse club COST found its famous $1.50 hot dog and soda combo back in the headlines as inflation bit harder to squeeze pockets further. The hot dog combo and its rotisserie chicken, whose price has been pegged at $4.99 since 2009, are the retailer’s loss leaders that lure in customers who are likely to buy other items as well.

This could be helpful, especially in times like these in which, according to CFO Richard Galanti, even COST’s relatively well-to-do members have been ditching pricier beef products for cheaper meats such as pork and chicken, while others are bypassing the fresh meat aisle entirely and opting for cheaper canned meat and fish products with longer shelf life. Even the retailer has been forced to restrict itself from handing out unlimited free samples to shoppers.

Therefore, with the understanding that apples-to-apples comparison is not possible here, let us closely examine the fundamentals of the three retailers.

Recent Performance

For the fiscal second quarter that ended June 30, despite the closing of 21 stores in 12 states and DC this year, the big-box retailer surpassed Street expectations for both earnings and revenue for the fiscal 2024 second quarter that ended July 31. During the quarter, its revenue increased by 5.7% year-over-year to $161.6 billion, while its adjusted operating income increased by 8.1% year-over-year to $7.41 billion.

WMT’s e-commerce sales for the U.S. also jumped 24% year-over-year as customers bought more items from the company’s growing third-party marketplace and placed more orders for store pickup and delivery.

Consequently, the consolidated net income attributable to WMT increased by 53.3% year-over-year to $7.89 billion, while the company’s adjusted EPS increased by 4% year-over-year to $1.84.

For the fiscal 2023 third quarter that ended May 7, COST’s total revenue increased by 2% year-over-year to $53.65 billion. However, the net income attributable to COST declined by 3.6% and 3.8% year-over-year to $1.30 billion and $2.93 per share, respectively.

Lastly, TGT missed Wall Street’s sales expectations for the fiscal second quarter. Even its online sales declined by 10.5% year-over-year. TGT saw its first quarterly sales decline in six years on account of slowing traffic, rising shrink (theft), and backlash from a June Pride campaign. Consequently, the company’s total revenue declined by 4.9% year-over-year to come in at $24.77 billion.

However, given the higher margins on non-essential items compared to those for food items, TGT’s quarterly EPS of $1.80 exceeded Street expectations of $1.39 and the previous year’s EPS of $0.39.

Outlook and Expectations

Of late, retailers across the value chain have been preparing for the onset of the holiday season by managing and readjusting the inventory levels of their general merchandise. That is evident from queues of ships waiting at Asian ports as retailers are scrambling to shift excess stock.

However, with the Back-to-School season in its early days, all retailers are looking forward to the holiday season with cautious optimism.

Encouraged by the strong performance, WMT also raised its third-quarter and full-year guidance. It said it now anticipates consolidated net sales will rise by about 3% in the fiscal third quarter and 4 to 4.5% in the fiscal year.

In line with analyst estimates, WMT expects adjusted earnings per share for the third quarter and full year will be between $1.45 to $1.50 and $6.36 to $6.46, respectively. The company also has an impressive earnings surprise history of surpassing consensus EPS estimates in each of the trailing four quarters.

Since general merchandise prices have dropped compared with last year, WMT saw a “modest improvement” in sales of big-ticket and discretionary items like electronics and home goods, such as blenders, hand mixers, and other kitchen tools in the second quarter, as some consumers cook more at home during the quarter.

WMT, being able to attract customers due to discounted groceries, is best positioned to capture the uptick relative to other grocers. However, it remains to be seen whether WMT is able to keep the customers they have gained once they feel confident enough to resume splurging on big-ticket and luxury items.

Ahead of its earnings release, analysts expect COST’s revenue and EPS for the fourth quarter of fiscal year 2023 to increase by 8.3% and 14.5% year-over-year to $78.08 billion and $4.82, respectively. As a result, its revenue and EPS for the fiscal would increase by 6.3% and 9.8% year-over-year to $241.23 billion and $14.57, respectively.

Since consumers are facing new challenges, such as the return of student loan payments, TGT slashed forecasts for the year ahead. In line with analyst estimates, the company expects comparable sales to decline by about mid-single digits for the full fiscal year and earnings per share to range from $7 to $8, from a previously expected range of $7.75 to $8.75. Street also expects TGT’s full-year revenue to decline by 1.8% to $107.15 billion.

TGT is taking measures to stem the rot, including remodeling its digital experience in the next three months. The remodeled site would include different landing experiences, more personalized content, enhanced search functionality, ease of navigation, and other updates to bring more joy and convenience to our digital guests.

Price Actions and Valuations

WMT’s stock has dipped 0.7% over the past month but gained 11.6% over the past six months to close the last trading session at $157.82. Its forward P/E multiple of 24.43 is 32.6% higher than the industry average of 18.42. Similarly, its forward Price/ Book of 5.05x is 83% higher than the industry average of 2.76x.

COST’s shares have lost 5.7% over the past month but have gained 9.7% over the past six months to close the last trading session at $534.01. Its forward P/E multiple of 36.65 is 99% higher than the industry average of 18.42. Similarly, its forward Price/ Book of 9.36x is 238.9% higher than the industry average of 2.76x.

TGT’s stock has plummeted 9.2% over the past month and 27% over the past six months to close the last trading session at $121.79. Given the recent price decline, TGT’s forward P/E multiple of 16.04 is 12.9% lower than the respective industry average, while its forward P/B of 4.38x exceeds the industry average by only 58.5%.

POWR Ratings

WMT has an overall rating of A, which equates to a Strong Buy in our proprietary POWR Ratings system. On the other hand, both COST and TGT have overall ratings of C, translating to a Neutral rating. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. WMT also has an A grade for both Stability and Sentiment and a B for Quality and Growth. COST has a B grade for Stability and Sentiment, while TGT has a B grade for Value.

Beyond what we’ve stated above, please click on the respective links for additional ratings of WMT, COST, and TGT.

Podium Sequence

Of the 37 stocks in the A-rated Grocery/Big Box Retailers category, WMT, COST, and TGT are ranked #3, #28, and #29, respectively.

With increased borrowing costs expected to keep weighing on the economy in the foreseeable future, WMT is expected to keep benefiting from consumers’ shift to groceries and essentials, which could offset weaker clothing and electronics sales until a potential recovery at the beginning of the holiday season.

Meanwhile, in order to manage and improve slimmer margins from food items compared to general merchandise, WMT has been doubling down on initiatives to increase the efficiency of its operations through innovations in packaging and Artificial Intelligence (AI) and Machine Learning (ML).

Hence, given its stronghold on sales of low-margin and high-volume groceries and other essentials, shoots of recovery in discretionary expenditure, and ever-growing moat by figuring out what the customer wants to buy and how best to get it to them, WMT’s prospects appear to be the most promising of the three retail chains.

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WMT shares were trading at $158.36 per share on Monday morning, up $0.54 (+0.34%). Year-to-date, WMT has gained 12.97%, versus a 16.23% rise in the benchmark S&P 500 index during the same period.

About the Author: Santanu Roy

Having been fascinated by the traditional and evolving factors that affect investment decisions, Santanu decided to pursue a career as an investment analyst. Prior to his switch to investment research, he was a process associate at Cognizant. With a master's degree in business administration and a fundamental approach to analyzing businesses, he aims to help retail investors identify the best long-term investment opportunities. More...

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