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The Target of the Retail Industry

Sunday - 4/7/2013, 9:41pm  ET

Much like the current situation in the delivery and freight industry, where FedEx is the growth story and UPS is the dividend stability story, I believe this same situation exists between the top two diversified retailers, Target and Wal-Mart . Question is, which is growing and which is stalling? 

Granted Wal-Mart is the leading global retailer, I believe Target offers the best growth prospects. So Target's the growth story of the industry, Wal-Mart is the dividend paying cash generator of the industry. But wait, they both pay a dividend yield of at least 2%; Target could well be both a growth and income story.

Target's Initiatives

Some of Target's big moves that should help the company keep pace with Wal-Mart include store expansion and remodeling. The retailer appears to be ready to take Wal-Mart head on in the retail industry after selling off its credit card portfolio to TD Bank Group last year for some $5.7 billion.

Target is also remodeling current stores and ramping up its "P-fresh" model, which induces expanding its grocery offering and taking market share from the likes of Kroger. Currently the company is focused in the U.S. but has plans to move to Canada and Latin America in the near term, planning to open over 120 stores in Canada during 2012. 

Target also has room to expand within the U.S. The company is hoping to tap the urban market with smaller formatted stores known as CityTarget. These stores will be between 60,000 to 100,000 square feet, versus the standard 125,000 to 180,000 format. The retailer already operates five CityTarget stores across LA, Seattle, Chicago  and San Francisco, with plans to open 15 to 20 CityTarget stores in 2013. 

Target also had John A. Levin's Levin Capital Strategies owning the most shares of the company at the end of 2012, worth close to $99 million, comprising 2% of its total 13F portfolio (check out how hedge funds are trading Target). 

The Competition

One of the downsides to Wal-Mart is its gigantic scale. The company is the largest private retailer in the world with 8,500 stores in 15 countries. This has indeed helped the company be able to weather any number of economic storms, as exhibited by its 10-year average 0.3 beta, but I think this scale limits the company's ability to grow as fast as Target. Target has a market value that is less than a fifth of Wal-Mart.

However, billionaire Warren Buffett is still a big believer of Wal-Mart, having the largest position among hedge funds in Wal-Mart at the end of 2012, with a $3.2 billion position that made up 4.3% of its total 13F portfolio. Coming in as the second largest hedge fund shareholder was Bill Gates Foundation (check out all hedge funds loving Wal-Mart).

Wal-Mart also operate the warehouse chain Sam's Club, which helps diversify revenues somewhat. Wal-Mart got around 12% of 2012 revenues from Sam's Club. Costco , however, is becoming an impressive foe in the bulk retail sector. Costco is looking to expand its presence, opening 16 new locations in 2012, and announcing plans to open another 28 in 2013. 

Its recent quarterly announcement (fiscal 2Q 2013) showed that international same store sales continue their impressive growth, growing 6% year over year for the quarter. The warehouse company trades at a valuation well above the conventional retailers at 25 times earnings, making the stock expensive and putting its PEG relatively high at 1.8. Billionaire Warren Buffett also happened to be one of Costco's largest shareholders at the end of 2012 (check out Buffett's high upside picks).

Discounted Competition

Although Wal-Mart's "everyday low prices" help the company draw in customers feeling pressure from high unemployment and a slow economy, the rise of the discount retailers have helped eat into that market share. The discount industry leader, Dollar General , has been snatching up lower end consumers with its discount prices and smaller store size. The company has been on a tear throughout the economic crisis, growing average sales per square foot from $163 in 2007, to $165 in 2008, $180 in 2009, $195 in 2010, $201 in 2011, and finally $213 in 2012. 

Billionaire Stephen Mandel’s Lone Pine Capital has taken notice of this robust growth and placed the stock as one of its top five holdings at the end of December (see more of Mandel's stock picks).

What's more is that over the same 2007 to 2012 time period, the company was also growing its operating margins, steadily rising from 3.6% in 2007 to 10.1% in 2012. Dollar General is also expected to continue its impressive growth despite a rebounding economy. Analysts expect the company to grow EPS by an annualized 16.5% over the next five years, giving the company a 1.1 PEG ratio.  

By the Numbers

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