Walmart (WMT) vs. Costco Wholesale (COST) vs. Target (TGT): Navigating Inflation's Impact on Grocery Chains

U.S. domestic consumption has been on a roller coaster ride over the past three years. People have gone from not being free enough to spend practically free money to spending like there’s no tomorrow.

That, in turn, led to a not-so-transitory inflation, the hottest since the 1980s, forcing the Federal Reserve to implement eleven interest-rate hikes in a span of 16 months, taking the benchmark borrowing cost to 5.25%-5.50%.

Meanwhile, with the pandemic firmly in the rear-view mirror, Americans have been going above and beyond to compensate for the years spent indoors trying to substitute real experiences with virtual ones.

However, with the stash of stimulus cash fast dwindling, average American consumers have been forced to go bargain hunting to squeeze out the maximum possible value from money, which has gotten dearer so that more of it can be set aside in favor of outdoor experiences instead of manufactured goods.

Consequently, they have been forced to trade down to budget-friendly retailers, leaving the businesses that offer something in between wrong-footed and stranded. Although budget retailers have lost sales from low-income consumers, that loss has been offset by increased business from the middle-income consumer segment.

However, not budget retailers are created equal. Hence, let’s take a closer look at three such retailers' varying fortunes and prospects.

Walmart Inc. (WMT) has been relatively immune to the seismic shifts in the consumption ecosystem, as discussed in our piece on June 22. Hence, despite closing 21 stores in 12 states and DC this year owing to poor financial performance being cited by the company, the big-box retailer surpassed Street expectations for both earnings and revenue for the second quarter of fiscal year 2024.

Encouraged by the strong performance, WMT also raised its full-year guidance. It said it now anticipates consolidated net sales will rise by about 4 to 4.5% in the fiscal year. It expects adjusted earnings per share for the full year will be between $6.36 and $6.46.

WMT’s e-commerce sales for the U.S. also jumped 24% year-over-year as customers bought more items from the company’s growing third-party marketplace and placed more orders for store pickup and delivery.

With the double-edged sword of inflation cutting both ways, while WMT attracted new and more frequent shoppers, including younger and wealthier customers looking for both convenience and value, the shift back to services is taking a bite out of sales of goods, particularly after a pandemic-fueled spending boom. Consequently, consumers have been buying fewer discretionary items, such as electronics and home appliances, and trading down for lower-priced items.

Since general merchandise prices have dropped compared with last year, WMT saw a “modest improvement” in sales of big-ticket and discretionary items like electronics and home goods during the quarter. According to the CFO, John David Rainey, the retailer also had fewer markdowns as the inventory was down by 5% at the end of the second quarter compared to a year ago.

Moreover, as food prices remained steady, and some staple grocery items have fallen, shoppers have been buying more fresh meats, seafood, and eggs, accounting for nearly 60% of the annual U.S. sales for the nation’s largest grocer.

Although consumers are facing newer challenges, such as the return of student loan payments, with the Back-to-School season getting off to a strong and early start and with stock price gains of more than 10% year-to-date, WMT is looking forward to the holiday season with cautious optimism.

Warehouse club Costco Wholesale Corporation (COST) found its famous $1.50 hot dog and soda combo back in the headlines as inflation bit harder to squeeze pockets further. The hot dog combo and its rotisserie chicken, whose price has been pegged at $4.99 since 2009, are the retailer’s loss leaders that lure in customers who are likely to buy other items as well.

This could be helpful, especially in times like these in which, according to CFO Richard Galanti, even COST’s relatively well-to-do members have been ditching pricier beef products for cheaper meats such as pork and chicken, while others are bypassing the fresh meat aisle entirely and opting for cheaper canned meat and fish products with longer shelf life. Even the retailer has been forced to restrict itself from handing out unlimited free samples to shoppers.

Ahead of its earnings release, analysts expect COST’s revenue and EPS for the fourth quarter of fiscal year 2023 to increase by 8.3% and 14.5% year-over-year to $78.05 billion and $4.82, respectively. As a result, its revenue and EPS for the fiscal would increase by 6.3% and 9.8% year-over-year to $241.23 billion and $14.58, respectively. That could lend momentum to the stock, which has gained more than 19% year-to-date.

At the other end of the spectrum, Target Corporation (TGT), which also caters to value-conscious shoppers, missed Wall Street’s sales estimate for the fiscal second quarter and consequently slashed forecasts for the year ahead. The company expects comparable sales to decline by about mid-single digits for the full fiscal year and earnings per share to range from $7 to $8, from a previously expected range of $7.75 to $8.75.

One of the reasons behind this bearish outcome and outlook could be the shifting patterns of consumer expenditure, which was redirected to prioritize groceries over discretionary items to make room for outdoor experiences.

As a result, TGT, which caters to a segment generally more affluent than that served by WMT and draws only about 20% of its yearly revenue from grocery, found its top line getting negatively impacted and even its online sales declining by 10.5% year-over-year. However, given the higher margins on non-essential items compared to those for food items, TGT’s quarterly EPS of $1.80 exceeded Street expectations of $1.39.

TGT is taking measures to stem the rot, including remodeling its digital experience in the next three months. The remodeled site would include different landing experiences, more personalized content, enhanced search functionality, ease of navigation, and other updates to bring more joy and convenience to our digital guests.

However, even as WMT has been experiencing a “modest improvement” in discretionary goods, such as blenders, hand mixers, and other kitchen tools in the second quarter, as some consumers cook more at home, TGT has not shared the same optimism.

With the Back-to-School season in its early days, sales of frequency categories, such as food and beauty items, have not been enough to offset weaker discretionary sales at the retailer, which has seen its stock price decline by more than 19% since the beginning of the calendar year.

Bottom Line

With increased borrowing costs expected to keep weighing on the economy in the foreseeable future, WMT is expected to keep benefiting from consumers’ shift to essentials, which could offset weaker clothing and electronics sales until a potential recovery at the beginning of the holiday season.

Meanwhile, in order to manage and improve slimmer margins from food items compared to general merchandise, WMT has been doubling down on initiatives to increase the efficiency of its operations through innovations in packaging and Artificial Intelligence (AI) and Machine Learning (ML).

Hence, given its stronghold on sales of low-margin and high-volume groceries and other essentials, shoots of recovery in discretionary expenditure, and ever-growing moat by figuring out what the customer wants to buy and how best to get it to them, WMT’s prospects appear to be the most promising of the three retail chains.