BENTONVILLE, Ark. -- The impact of Wal-Mart on the rest of the food industry is unlikely to abate for years to come, according to analysts attending the company's 10th annual analysts' conference here late last month.
Wal-Mart's ongoing expansion of supercenters makes it "the largest long-term competitive threat to food retailers," Mark Wiltamuth, an analyst with Morgan Stanley, New York, said. "As Wal-Mart's expansion and the growth of club stores, dollar stores and other nontraditional formats increase competitive pressures for grocers, there could be long-term risk for slowing sales and/or margin pressure for the major grocers."
According to Wiltamuth, the addition of 220 to 230 supercenters next year will position Wal-Mart for 20% growth in grocery-related sales, compared with 3% or less for the industry in general and 4% to 5% for the major chains. Combined with the addition of 35 to 40 Sam's Clubs, "the supermarket industry will see rising competition in the years ahead. And should the pricing environment erode further or market-share battles become more heated, gross margins could fall, which could translate into earnings shortfalls [for some companies]."
He said Safeway and Albertsons seem most vulnerable in the next few years as Wal-Mart begins opening supercenters in California -- because the majority of supercenters involve expanding established Wal-Mart discount-store locations, and Wiltamuth estimates that 27% of Safeway's and 24% of Albertsons' California stores are within 10 miles of existing discount stores.
George Strachan, an analyst with Goldman Sachs, New York, said Wal-Mart's plan to add 50 million square feet of new selling space in 2004 -- the equivalent of the company's total square footage in 1985 -- is a negative for the rest of the retailing industry. "None of this is good for supermarkets, Costco or other direct competitors," he said.
Steve Chick, an analyst with J.P. Morgan Securities, New York, said he believes Wal-Mart's continued growth in food and sundries at supercenters and discount stores means "long-term pressures on traditional food retailers [will] persist."
Among the issues discussed during the two-day conference, as reported in last week's SN, were Wal-Mart's pending introduction of supercenters into California next year; the company's willingness to build supercenters closer together; the integration of procurement for Wal-Mart discount stores, supercenters and Neighborhood Markets with Sam's Clubs; the revitalization of Sam's; and the company's international expansion prospects.
Robert S. Drbul, an analyst with Lehman Brothers, New York, said the decision to open supercenters in closer proximity to each other reflects Wal-Mart's willingness to sacrifice short-term comparable-store sales gains for long-term returns. He said the company's willingness to cannibalize its own stores cost it 132 basis points at 102 supercenters last year, with the company expected to cannibalize sales at 164 supercenters this year and 237 in 2004.
"This is not to imply the company expects to see or is satisfied with declining returns on its investment," Drbul pointed out. "On the contrary, even with cannibalization, supercenters have a higher return on investment than the company average, and increasing the asset base on a high-return business improves the total company's returns."
Furthermore, cannibalization actually improves the customer experience and the stores' productivity levels due to a higher in-stock position, Drbul said. "Typically, Wal-Mart regains cannibalized sales within a year, so the net result of a more dense base of supercenters is increased market share, increased earnings and a higher return on investment."
Shari Schwartzman Eberts, an analyst with J.P. Morgan, said Wal-Mart is not completely immune to the economic challenges affecting the entire food industry but has the long-term strength to overcome them.
She said the company cited "more obstacles to strong sales than is typical, including an almost 3% impact from deflation, continued rollbacks and more cannibalization as backfilling increases, hurting comps by over 130 basis points, which should increase as supercenter growth continues. Translating sales gains to the bottom line has also gotten tougher with rising fuel, labor and health care costs.
"Given the tougher environment, mix continues to hurt margins as consumables and other lower-margin necessities continue to dominate sales. But Wal-Mart will weather the difficult environment better than most, given its ongoing market-share gains and its sustainable cost-structure advantage."
Deborah Weinswig, an analyst with Citigroup Smith Barney, New York, said consumables are driving strong customer traffic at Wal-Mart, along with "compelling prices and improvements made in apparel, consumer electronics, private label and branded merchandise."
The strength of consumables has prompted Wal-Mart to expand the food sections at its discount stores to 1,500 to 2,800 stockkeeping units spread over 3,000 to 4,500 square feet, Weinswig indicated. She said 433 of the company's nearly 1,500 discount stores have expanded food, "and whenever possible, all future discount stores will be opened with expanded food."