THE HEDGEYE EDGE
This looks to us like the best time in this economic cycle to bet on a significant bifurcation between Wal-Mart (WMT on the upside) and Target (TGT on the downside – leading to CEO being ousted). We have spent a significant amount of time analyzing the evolving competitive dynamics in the large-cap discretionary retail US marketplace, from both a top-down and bottom-up perspective. The fact is that WMT is overinvesting. TGT is underinvesting. That’s plain as day. It would be disingenuous of us not to call out WMT on the bull side of this battle given how much damage it is doing to incumbents. Bottom line is we really like Wal-Mart as a long.
IMMEDIATE TERM (TRADE)
Wal-Mart has many of the characteristics we like in this late cycle macro environment. It has low beta, high liquidity, big market cap, and low EPS expectations. Importantly, the trough earnings profile is due to WMT playing offense. TGT is on pure defense. Note to anybody in retail – there are two companies you don’t want to play defense against – WMT and AMZN. TGT is playing against both! WMT is trading at the biggest discount to the S&P in a decade – the classic ‘trough multiple on trough earnings’ phenomena that is so common in retail. But we’d argue that there will be a similar inverse reaction on the upside.
INTERMEDIATE TERM (TREND)
Wal-Mart just about has a "free pass" on earnings performance for the coming quarters since it lowered expectations during an analyst day 12 months ago. And that outlook was reiterated at last week's meeting with investors. We don’t see numbers going lower from here, with upside catalysts as costs roll off the P&L from over one year of increased investments, and market share gains continue. The sales to inventory spread has been positive for 5 consecutive quarters and the SIGMA sits in the bullish Quad 4 where inventories are being cleaned which is bullish for gross margins going forward.
LONG TERM (TAIL)
The share gap is clearly closing between WMT and TGT – to WMT’s benefit. The investment spread between WMT is the largest we’ve ever seen, as it started to widen back in mid-2014 around the same time TGT’s CEO Cornell started his tenure in Minneapolis. It now sits at 9 points wide over the last 2 quarters. That’s important given that Cornell is now two years into his tenure at TGT, and has his chosen team and strategy in place. Based on what we’ve seen to date, it can be characterized by prudent decision making when it comes to cutting Canada/Rx biz and a reluctance to spend in order to keep pace with the competition. Ultimately, unless this gap between TGT and WMT closes, we think WMT continues to win market share in the long run.
To be clear, this is the effect and not the cause of the broader strategic decisions WMT is making in order to ultimately drive traffic and win market share. There has been a clear deviation in the trend, with the spread between the two opening up to 1.2% in 1Q and 3.4% in 2Q, both in favor of Wal-Mart. The most recent metric is good for the biggest spread we’ve seen since the TGT data breach in 4Q13, and the widest gap over the past 5 years in a normal environment.
Most importantly, we don’t think this a near term statistical aberration, as WMT is putting the dollars behind the up-tick in traffic which will continue to propel outperformance while TGT sits on the sidelines. Perhaps more importantly, WMT has acquired its way into the e-comm game with Jet.com, while TGT is cutting costs and losing share. One key retail macro theme we highlight is that e-commerce in the US is accelerating, and doing so off a bigger base, at a rate that CEOs don’t appreciate. WMT gets it. 90% of others do not.
ONE-YEAR TRAILING CHART
