Walmart's New Strategy Could Hurt These Popular Stores

Jamal Carnette, CFA, The Motley Fool

Over the last two years, it's been clear Walmart (NYSE: WMT) is positioning itself as a competitor to Amazon. After paying $3.3 billion for e-commerce provider Jet.com in 2016, Walmart has increasingly encroached on Amazon's turf by attempting to lure Amazon's core consumer base, move into new industries, and replicate Amazon's disruption-focused mindset.

With all the excitement about its digital changes, Walmart's core terrestrial operations may have flown under the radar. Last year total revenue increased 3%, with the heavily watched Walmart U.S. comparable sales increasing 2.1%. While this figure was the highest growth rate since 2009, it does include e-commerce growth of 44%, which points to much slower growth from the physical channel.

Store aisle

Image Source: Getty Images

Needless to say, Walmart will continue to be led by its in-store sales for the intermediate future, and should work to grow traffic and sales in the channel. Its newest strategy should accomplish both goals, and deep-value retailers should be worried.

Going downscale for dollars

According to a research note from Raymond James, Walmart plans to go downscale to compete with dollar stores like Dollar Tree (NASDAQ: DLTR) and Dollar General (NYSE: DG). Walmart has been aggressive about discounting prices to compete against these deep-discounters, and the analyst firm feels Walmart is breaking through: it is downgrading the entire value-store segment.

Walmart digital CEO Marc Lore assuaged investor fears that the company was abandoning its core constituency to chase Amazon's sticky consumer base by noting Walmart would continue to focus on the bargain shopper with its in-store experience. The high/low positioning is wise; the U.S. economy is becoming more bifurcated, with the middle-class becoming smaller as the relative numbers of upper- and lower-class citizens grow.

Walmart grew its top line 3% last year, while Dollar Tree and Dollar General reported revenue growth of 7.4% and 6.7%, respectively. Therefore it makes sense for Walmart to try to compete with Amazon for the growing e-commerce business and for higher-end shoppers, while aggressively pursuing the growing dollar-store consumer cohort to grow foot traffic at the store level.

Tax cuts afford Walmart a great opportunity

Something to watch for in Walmart's results is the effect these plans have on margins. In the important holiday quarter, Walmart reported gross margins 61 basis points (0.61%) lower than in the prior-year's quarter, blaming product mix from sales in its e-commerce channel. It's likely aggressive discounting to beat dollar-store prices will continue to drag the company's above-the-line margins (operating margins, gross margins) lower.

However, it's a good time for Walmart to compete on discounting, because it's likely bottom-line profit margins will be aided by the recent GOP-led tax cut. The company forecasts a small yearly decrease in margins next year, but could surprise to the upside if lower prices lead to more foot traffic, sales, and store-level efficiency.

More broadly, however, it shows that although Walmart's attempts to compete with Amazon are widely covered, the company is wisely going down-market at the same time to win back the lower-income consumer. It was the bargain-hunter that built the Walton empire, so it makes natural sense for the company to try to retain this market.

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Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.