Grocery Wars Could Pose Risk to Wal-Mart Stock Upside

Wal-Mart (NYSE:WMT) is the largest retailer in the world based on revenues and competes with other retailers like Costco (NASDAQ:COST), Target (NYSE:TGT) and Amazon (NASDAQ:AMZN). Our price estimate for Wal-Mart’s stock stands at $65.42 which is about 19% above market price. We estimate that U.S. Wal-Mart stores constitute a little over 60% of the company’s value, while another 32% comes from international Wal-Mart stores.

A significant portion of Wal-Mart’s sales come from groceries, an area expected to see increasing competition going forward. Should the retail giant be concerned by this trend? According to one analyst, Wal-Mart commands about 33% share of the grocery market. ^[1] The chart below depicts the proportion of Wal-Mart’s sales broken down by product category. ^[2]

Wal-Mart Sales Breakup for 2009

Increasing Grocery Competition

Retailers that have traditionally specialized in general retailing and pharmacy products are now seeing the grocery segment as a potentially lucrative business. The interest is coming from stores like CVS, Walgreens and Target. Target invested $500 million in 2010 to expand grocery operations while CVS redesigned about 200 of its stores last year to accomodate grocery items. ^[1] CVS hopes to redesign about 1400+ stores overall to advance its push into groceries. ^[1]

Why Are Retailers Increasing Grocery Emphasis?

While grocery is a low margin business compared to general retailing, it has an indirect effect on sales of other items. According to one analyst, consumers tend to visit shops for groceries roughly 10 times as frequently as they visit pharmacy or general retail stores. ^[1] Market data suggests that people are likely to buy additional items like paper towels, nail polish or DVDs when they go to pick out their groceries.

Thus the strategy is not simply to increase profits from groceries, but to drive more traffic in stores to promote sales of other retail items as well. Target has stated that sales and traffic at stores with groceries are now about 6% higher than at stores without them. ^[1]

We can expect a lot of competition in this arena going forward. Wal-Mart stores, given their large size, tend to be located in relatively open parts of a city. Thus, consumers may be tempted to buy their groceries at drugstores rather than making a trip out to Wal-Mart.

Since groceries amount to more than half of Wal-Mart’s sales, this could be a serious issue for the company. The grocery war could cause collateral damage in sales of Wal-Mart’s other product categories, putting downward pressure on revenue per square foot figures. We currently project that Wal-Mart’s U.S. revenue per square foot will see slight growth in the years ahead, but increased grocery competition could add risk to our bullish outlook for the company.

Drag the trend line in the modifiable chart above to see the affect of various U.S. revenue per square foot scenarios on Wal-Mart’s stock value.

Register to win a free iPad. Visit our home page at trefis.com for details.

You can see the complete $65.42 Trefis price estimate for Wal-Mart’s stock here.

1. Big Retailers Fill More Aisles With Groceries, The New York Times, Jan 16 2011 [↩] [↩] [↩] [↩] [↩]
2. 10K report for year ending Jan 2010 [↩]