Wal-Mart's breather on lower prices

A break on heavy discounting from the nation's biggest retailer could give a little relief to its rivals.

By Suzanne Kapner, writer

NEW YORK (Fortune) -- Wal-Mart has won market share during the recession by relentlessly lowering prices -- a strategy echoed in its advertising slogan, "Save Money. Live Better."

Now some analysts see signs that the giant retailer may be taking a momentary breather on the price lowering front -- and that could be good news for Target and other competitors.

Wal-Mart's (WMT, Fortune 500) second-quarter earnings, released Thursday morning, showed a 1.5% decrease in U.S. sales at stores open at least a year. At the same time, gross margin increased 130 basis points, which helped the retailer produce earnings of 88 cents a share, at the high end of its guided range. Shares jumped $1.31, or 2.6%, to close at $51.82.

There are lots of reasons for the gross margin increase. Perhaps the biggest is the lower cost of food and consumable goods. Also at play is a huge reduction in inventory at U.S. stores, down $1.4 billion, or 6%, compared with a year ago. In the earnings conference call, Vice Chairman Eduardo Castro-Wright credited the lower inventory as a major reason for the company's strong profit performance. Wal-Mart has also made a big effort to stock more private label goods, which carry higher margins than do name brand products.

Analysts say there is yet another reason for the gross margin expansion: The discount retailer may not be discounting prices as aggressively as usual.

"Wal-Mart's gross margin expansion suggests a somewhat benign pricing environment, which should have positive implications across the discount space," wrote Goldman Sachs analyst Adrianne Shapira in a note to clients. One of the biggest beneficiaries is Target (TGT, Fortune 500), which has suffered from the perception that its prices are slightly higher than Wal-Mart's.

"Now we know why Target, Kohl's (KSS, Fortune 500) and others are showing such strong margins -- as we had suspected, Wal-Mart is not being its usual competitive self," David Berman of Durban Capital wrote in an email. He says he is not long or short Wal-Mart shares. Berman compared Wal-Mart's performance with Costco (COST, Fortune 500), which tends to willingly sacrifice margins to pass savings to consumers.

John Simley, a Wal-Mart spokesman, says Wal-Mart has continued to maintain a gap with competitors on pricing. "We are committed to price leadership, and we will maintain everyday low pricing," he says.

Craig Johnson, President of consulting firm Customer Growth Partners, says Wal-Mart doesn't need to continually slash prices to maintain its leadership. "Once you've achieved a low price position in the minds of the consumer it does not mean you have to keep lowering your prices all the time," he says.

That may be true and investors certainly like the higher margins, but consumers might feel differently. There are plenty of signs that consumer spending is still weak despite a general consensus that the recession has ended.

U.S. retail sales fell 0.1% in July, after two months of gains, despite the cash for clunkers program that many analysts hoped would revive the auto industry. Wal-Mart, which tends to serve as a bellwether for the economy because of its size, saw revenue decrease 1.4% in the second quarter to $100 billion.

True, the retailer benefited from government rebate checks issued a year ago, which made comparisons tougher, but not even Wal-Mart is immune to today's economic headwinds. Until that changes, consumers are going to be more concerned with "saving money" than they are with "living better." To top of page

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