Sunday, August 31, 2008

Walmart vs Target

Every month, media pundits compare the latest same store sales numbers of these two companies, extol the virtues of the one that has outperformed, and simultaneously deride the other. They will look for trends in the month to month same store sales exhibits, and use them to project that one company has done a great job, while the other is suffering from placeholder (examples include high gas prices, worsening consumer credit, charging too low a price, charging too high a price, etc.).

But overall, ignoring the minor month-to-month fluctuations that can and will take place in these businesses, which of these companies is the more profitable, and why? In this article we'll attempt to determine the relative strengths and weaknesses of each company to determine whether one business model offers better returns than the other.

To compare revenues, since Walmart is much larger than Target, it makes sense to compare them on a square foot basis. A chart showing the relative sales per square foot for several retailers is discussed in this article, and here it is reproduced specifically for these two retailers:

Clearly, Walmart owns a big advantage when it comes to sales per square foot. But this isn't the end of the story. It could very well be that Walmart charges such low prices, that although they generate a lot of sales, their markups are so low that their profit per square foot is also very low.

Therefore, here is a look at the operating margins of each company:

Clearly, Walmart's margins are much smaller than those of Target. This suggests that Walmart is indeed driving its high sales numbers by encouraging customers to buy from them due to low prices. So what's the end result? If we multiply operating margins by our sales to square foot, we can estimate each of these companies' before tax profit per square foot as follows:

Interestingly enough, we see that Target generates a higher profit per square foot than does Walmart! Of course, this represents only the beginning of our analysis, as it does not tell the full story. Although one could argue based on this data that Target should continue to expand rapidly and compete with Walmart, it's unclear whether Target's target market is as large as that of Walmart (for example, many Walmart shoppers may not switch to Target due to Walmart's seemingly lower prices). Nor does this suggest that Target is the better stock investment, as we have not considered debt levels, return on equity, or the current stock prices. However, this serves as a useful starting point as we dig into these two companies a little bit deeper...

Disclosure: The author has no position in either WMT or TGT


mp said...

inventory turnover would also be a good thing to look at with these retailers. WMT has higher inventory turnover averaging around 8 meaning TGT takes longer to sell their items with inv. turnover of 6

Anonymous said...

where did you get your data?

Saj Karsan said...

Hi Anon,

Annual reports for both companies will tell you their retail square footage along with each of their revenues and costs (from which you can calculate operating margin).