Discounters will rule

Posted by Dan Hung

July 14, 2008

Last week, Walmart, Target, and Costco all reported June sales growth well in excess of expectations with Walmart besting everyone and going as far as to up their guidance for Q2 2008. Some analysts seem skeptical, though, as they believed that increased sales were more a result of the first round of government stimulus checks and will not represent consumer appetite going forward. But, are stimulus checks really all that’s at work here?

The reality is that with inflation in food and fuel prices, our real incomes have been driven down. We are poorer today than we were a year ago and that’s not just because of underperforming stocks or real estate assets. It’s because nominal incomes will now buy less. While a lot has been made of the Fed’s following of the core-CPI, an inflation index which measures consumer products ex fuel and food costs, news on tame growth in core-CPI is really misleading.

I’m not claiming that the Fed is wrong to only look at core-CPI. In fact, this makes complete sense as far as economic policy is concerned given that little can be done about the volatile prices of food and fuel. Unfortunately for regular consumers, it is not core-CPI that matters but exactly the fuel and food costs that are, for now, out of our control. New, fuel-sipping/alternative energy cars won’t be ready for at least a few years. It will take decades to fully implement large-scale alternative energy power plants (and that’s without the political tussle that might take years in and of itself). So, it might not take all that much for us to see a real improvement in the performance of the Walmarts, Targets, and Best-buys of the world.

As real incomes fall and credit tightening continues, many who thought they had graduated from the cash-strapped target demographic that feeds big-box retailers will fall right back in. While the current high-single digits sales growth rate sported by a very mature retailer like Walmart may not be sustainable, continued growth at big box chains like Walmart, Target, and even Kohls at the expense of department stores like Nordstrom, JC Penny, and and Dillards could continue for a much longer time than many expect.

Disclosure: No position in the companies mentioned at this time.