Why Wal-Mart’s Revenue Per Square Feet Will Improve Going Forward

Wal-Mart‘s (NYSE:WMT) U.S. revenue per square feet (a measure of store productivity) declined slightly from $437 in 2008 to $424 in 2010, due to a pullback in consumer spending during the economic downturn. The figure ticked up a little to $425 in 2011 and improved further to $435 in 2012, as the macro-economic conditions improved and buyers returned to stores. However, the retailer’s revenue per square feet declined again to $434 in 2013 as increase in payroll taxes weighed on consumer spending, and buyers diverted their spending to long lasting products in the wake of low mortgage rates.

Going forward, we expect this figure to improve consistently, driven by Wal-Mart’s aggressive small store expansion, the slow roll-out of Supercenters, an increase in online sales and growth in the grocery business. In addition, growth in U.S. GDP and inflation will have a positive impact on the retailer’s revenue per square feet. However, the consistent decline in foot traffic across the retail industry on account of gradual online shift will continue to weigh on Wal-Mart. We believe that the retailer will lose more from a decline in store traffic, than it will gain from incremental online sales. Overall, we expect Wal-Mart’s revenue per square feet to increase at a compound annual growth rate of close to 2% for the next six-seven years.

Our price estimate for Wal-Mart stands at $81, which is just below the current market price.

See our complete analysis for Wal-Mart

Economic Growth and Inflation

Since the recession of 2008-2009, the U.S. economy has shown signs of a slow recovery. Although it is not likely to reach pre-recession levels any time soon, a gradual improvement in consumer confidence and lower unemployment should positively impact consumer spending at Wal-Mart. Inflation is another factor that drives the growth for the same sales volume and will aid growth in the retailer’s revenue per square feet. For the next five-six years, the U.S. annual real GDP growth rate and inflation rate are expected to be roughly around 2.5% and 2%, respectively. ^{[1] [2]} This sums up to a nominal GDP growth rate of about 4.5% for the long-term. However for the past few years, Wal-Mart’s revenue per square feet growth has lagged behind the U.S. nominal GDP growth rate by a significant amount. This can be attributed to the effects of self-cannibalization resulting from Wal-Mart’s expansive reach in the country. Hence, we project the retailer’s revenue per square feet to increase by only around 1.5% annually on account of the economic growth. Remaining 0.5% can come from the company’s efforts to improve its store productivity, growth of grocery business and online sales, partially offset by a decline in foot traffic.

Growing Proportion of Small Stores

Traditionally, Wal-Mart has been serving customers who make less frequent store trips, with its large stores located on the outskirts of a city. It hasn’t been as effective in catering to buyer needs for easy access, for which they usually go to a traditional convenience store. As a result, local convenience, dollar and grocery stores have been nibbling at Wal-Mart’s customer base. Expanding its smaller format network provides Wal-Mart with a great opportunity to win back those customers, driving them from alternative stores to its Neighborhood markets. Wal-Mart’s small stores usually stock products that have high selling frequencies and therefore, generate higher-than-average revenue per square feet. As the proportion of small stores increases in the company’s overall store base, its overall revenue per square feet can move upwards. This can happen with aggressive expansion of small stores and slow roll-out of typical big-box stores. Wal-Mart is doing both.

Wal-Mart’s Supercenters have been struggling with weak traffic for some time now and in response, the company has decided to open fewer Supercenters in the coming year. CEO Doug McMillon believes that there are a couple of reasons apart from online shift that are responsible for the slump in foot traffic. He stated that in-stock levels in several stores aren’t up to the mark and the checkout lines are too long, which is discouraging buyers from visiting Supercenters. Understandably, the retailer has significantly reduced its Supercenter roll-out for the next year to just 60-70 outlets. In the years to come, this figure may decline further.

On the small store front, Wal-Mart has been doing very well, which is encouraging it to continue the expansion of this format. During the fourth quarter of fiscal 2014, comparable sales at small stores increased by about 5%. Interestingly, the figure increased by a similar amount in all three quarters of fiscal 2015. In fact, the growth is accelerating. Comparable sales increased by 5% in the first quarter, 5.1% in the second and 5.5% in the third. In October last year, the retailer unveiled plans to open 120-150 small stores, and 115 Supercenters in fiscal 2015. Soon after, it uplifted its expansion plans to about 270-300 small stores in the U.S in fiscal 2015. However in its last update, Wal-Mart lowered its fiscal 2015 target slightly to 240 stores and set its fiscal 2016 target at 200. Nevertheless, small store expansion plans still look aggressive in the context of the retailer’s overall store growth.

Growth in Online Sales with Omni-Channel Initiatives

Although Wal-Mart’s online business does not contribute much to its overall revenues, growth in e-commerce revenues can help its overall store productivity. The company can bring in incremental revenues through its web channel with the same store base, which is a favorable condition for its revenue per square feet. During the recently concluded quarter, Wal-Mart’s e-commerce sales continued their steady growth momentum as global e-commerce sales increased by 21%, with a sturdy performance in almost all markets. Overall, online sales contributed 20 basis points to net comparable sales. Going forward, Wal-Mart’s e-commerce business is likely to expand, even though it won’t get big enough to have a material impact on the company’s growth. Forrester expects e-commerce sales in the U.S. to increase at a compound annual growth rate of 9.5% between 2013 and 2018. ^[3] We believe that being the largest retailer in the country with an expansive product variety, Wal-Mart can remain at the forefront of this growth.

However for Wal-Mart, e-commerce accounts for just 2% of its overall revenues and the figure has increased by only about 50 basis points over the last year and a half despite the retailer’s aggressive efforts. ^[4] As a result, rather than growing e-commerce as a separate channel, Wal-Mart is looking to integrate its physical and digital channels. Known as omni-channel retailing, this has become a prevalent trend in the industry. While the retail giant has deployed several initiatives – such as “buy online and pick up in store” and layaway – to bolster its omni-channel platform, it still remains far from its goal. Nevertheless, it is a start and Wal-Mart must take giant strides from here on to expand its online business. In a recent update, the company stated that it is planning to increase investments in e-commerce by close to 50% next year. ^[5]

Growing Share of Groceries

Since consumer spending on groceries is non-discreatonary and therefore, less correlated to macro-economic factors, it has been one of the prime focus areas for Wal-Mart. The company has been aggressively converting its Discount stores to Supercenters, that offer a complete range of grocery items. Additionally, it has been increasing the number of grocery SKUs in its existing stores and launching various in house brands, which are cheaper than national brands but comparable in quality. As a result of these efforts, the share of groceries in Wal-Mart’s overall sales has jumped from 24% in 2002 to 55% currently. Given that groceries are a big market segment, accounting for annual sales of over $560 billion, it makes sense for Wal-Mart to continue its aggressive foray in this arena. As the share of groceries moves higher, overall revenue per square feet will improve.

However, Fall in Foot Traffic will have a Negative Impact

With increasing Internet penetration and proliferation of smartphones and tablets, U.S. buyers have been making more purchases online. Subsequently, they are visiting fewer stores, which is troubling large retail chains such as Wal-Mart and Target (NYSE:TGT). ShopperTrak reported a few of months back that foot traffic in U.S. stores had declined by close to 5% in almost every month of the preceding two years. ^[6] This trend is likely to continue in the future and big retail chains will have to come to terms with the fact that the big-box format has almost run its course. Since Wal-Mart operates over 4,000 stores in the U.S. and has an online channel that contributes an insignificant amount  to overall revenues, decline in foot traffic is having a greater impact than increase in online sales. This trend will most likely continue in the long run, unless Wal-Mart finds a way to bolster its online business and omni-channel platform.

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1. GDP Forecast, IMF [↩]
2. Inflation, IMF [↩]
3. US eCommerce Forecast: 2013-2018, Forrester, May 12 2014 [↩]
4. Gasoline Savings Flow To Wal-Mart’s Carts, The Wall Street Journal, Nov 13 2014 [↩]
5. Walmart will accelerate investments in e-commerce and moderate global square footage growth, Walmart, Oct 15 2014 [↩]
6. Shoppers Are Fleeing Physical Stores, The Wall Street Journal, Aug 5 2014 [↩]