Wal-Mart Stays Stingy On Discounting, Still On Target For $66 Stock Price

Prices are low but no lower than usual

Wal-Mart seems to be adopting a mixed approach to drive holiday sales instead of just purely discounting all the products to drive store volumes.

While this signals the retailer’s increased confidence for holiday shopping, it also represents a broader development that the U.S. consumer might finally be growing more confident with regard to economic outlook. ?This should also benefit other retailers that compete with Wal-Mart like Costco, Target and Sears.

This bodes well for Wal-Mart as we maintain our bullish take on the company driven by expected improvements in sales metrics (like revenue per square foot) and stable profit margins. Our price estimate for Wal-Mart’s stock currently stands at $65.42, which is about 22% above current market price.

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Retracting Some Initial Price Rollbacks ?

While the economic growth has been sluggish in 2010, there were indications that the fourth quarter might be stronger than expected from early reports. October data suggested that due to payroll increases and improved employment, the 4th quarter would be strong. ^[]

Then November retail sales data released last week prompted economists to boost their forecasts even further. ^[]With confirmation that consumers are willing to spend this holiday, Wal-Mart decided to ease up on its initial price rollbacks on many items. We believe this will help support margins as the retailer can drive sales without heavily discounting.

Smartphone Discounts Could be Strategic

Wal-Mart is maintaining its discounts on smartphones like Apple’s iPhone 4. ^[] Given that smartphones are some of the hottest selling items this holiday season and Wal-Mart wants to both attract customers and improve its sales metrics like revenue per square foot, this strategy makes sense. The retailer is increasingly moving into selling consumer electronics – a topic we discussed in a recent article Will Best Buy?s Earnings Miss Weigh on Wal-Mart? – and is one of the key beneficiaries of Best Buy’s recent stumbles in its holiday sales push.

As we enter the home stretch on holiday sales, we expect to see some strong numbers out of Wal-Mart.

You can see the complete $65.42 Trefis price estimate for Wal-Mart’s stock here.

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Discounting Steroid-Enhanced Economic Performance

He likes stimuli

During the 1980s and 1990s, ignorance was bliss. The global economy was growing nicely, and analyzing it (or even paying attention to market cycles) seemed like a waste of time, as the economy came in only three flavors: good, great and awesome. Even if you misread the flavor, the downside was that you’d just make a little less money. Value investors prided themselves on being bottom-up-only analysts, focused on scrutinizing individual stocks, while top-down analysis– making investment decisions by looking only at the macro picture–became unfashionable, viewed as market timing.

Prolonged and virtually uninterrupted growth brought complacency, excesses, and debt. Bottom-up-only analysis worked until it stopped working, as investors discovered during the recent crisis that the global economy can come in additional flavors: bad, horrible, and downright nasty. Today the cost of misreading the economy is much higher.

Two years ago the Great Recession waltzed in to the great surprise of homeowners, the Fed, and the banks and everyone discovered that house prices don’t always go up. The financial sector, the lifeblood of our economy, started to drown in the sea of bad debt. As the troubles in that sector began to spill into the real economy, the government felt it had no choice but to step in, and the bailouts and stimuli began.

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Today it is hard to take a walk through our economy and not meet a friendly Uncle Sam; he is everywhere. He’s buying long-term bonds and thereby keeping long-term interest rates artificially low. Since he took over the defunct (for all practical purposes) Fannie Mae and Freddie Mac, he is the U.S. mortgage market, because those organizations account for the bulk of mortgages originated. Of course, he is also on the hook for their losses.

Our dear Uncle Sam rolls in style; he doesn’t know how to bail out or stimulate on the cheap. U.S. government debt (at least, the debt that is on the balance sheet) leaped from about 60 percent of GDP before the Great Recession to more than 100 percent in 2010. The party of overleveraged consumers has been crashed by an over-leveraged government.

To understand the consequences of the Great Recession, consider this analogy: The U.S. economy is like a marathon runner who runs too hard and pulls a hamstring, but finds himself with another race to run. So he’s injected with some industrial-strength steroids, and away he goes. As the steroids kick in, his pace accelerates as if the injury never happened. He’s up and running, so he must be okay. This is the impression we get, judging from his speed and his progress. What we don’t see is what is behind this athlete’s terrific performance are the steroids, or, in the case of our economy, the stimulus.

Obviously, we can keep our fingers crossed and hope the runner has recovered from his injury, but there are problems with this thinking. Let’s address them one by one:

? Serious steroid intake exaggerates true performance. Economic stimulus creates an appearance of stability and growth, but a lot of it is teetering on a very weak foundation of government intervention.

? Steroids are addictive; once we get used to their effects, it is hard to give them up. When the first home-buyer tax credit expired, it was extended for anyone with the patriotic ambition to buy a house. It is hard to give up stimulus, because the immediate consequences are painful, but long-term gain has to be purchased by short-term discomfort.

? The longer we use steroids, the less effective they are. Take Japan, which was on the stimulus bandwagon for more than a decade. With the exception of tripled government debt, Japan has nothing to show for its efforts; the economy is mired in the same rut it was in when the stimulus started.

? Steroids damage the body and come with significant side effects. In the case of the economy, the side effects are higher future taxes and increased government debt, which brings on higher interest rates and thus below-average economic growth. The hopes that we’ll transition from government steroid injections back to an economy running on its own are overly optimistic.

So what does this mean for investors? When we purchase a stock, we are buying a stream of future cash flows. By doing only bottom-up analysis, investors implicitly assume that external factors (the winds and hurricanes of the global economy) have no impact on these cash flows. That is a brave and careless assumption, especially in a poststeroid world. Instead, investors should take a more holistic approach, mixing bottom-up insights with top-down analysis.

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