Battle of the Retailers: Who Comes Out on Top?

Key Points

• Consumer spending around the holidays is expected to reach record levels this year.
• Retailers like Walmart, Target, and Costco have faced declining spending trends due to inflation, but each has worked to navigate these barriers and achieved some degree of success.
• Standout business developments include Walmart's rapidly growing Walmart+ program and Target's successful promotional campaign.

Consumer spending during the upcoming holiday season is forecast to reach a record-high $902 per person across gifts, food, decorations, and other shopping needs, according to the National Retail Federation. Retail stores in the consumer staples and consumer discretionary sectors are likely to be major beneficiaries of this uptick in holiday-related spending, as usual. This increase in consumer activity will be a welcome change after customers across the country have tapered discretionary spending due to the lingering impact of inflation.

For investors, the seasonal bump in retail business is an attractive, though expected, bonus. However, a retail company's ability to continue to draw in customers beyond the holiday rush is likely even more important. Three major retailers—Walmart Inc. NYSE: WMT, Target Corp. NYSE: TGT, and Costco Wholesale Corp. NASDAQ: COST—are long-time favorites among Wall Street analysts for just this reason. Investors interested in retail thus often find themselves comparing these leading store brands.

Walmart: Subscription Fees, Ad Revenue Growth

Walmart has continued to find new ways to build customer loyalty, including its highly popular Walmart+ subscription membership service and its growing array of private-label offerings. Walmart+ is the company's version of Amazon Prime, with streaming access, and other benefits for an annual fee. Walmart+ memberships have boomed in recent quarters, reaching nearly 30 million as of this summer.

With its growing in-house brands, including "bettergoods" and "Member's Mark," Walmart has found a way to simultaneously build brand loyalty while building sales across often-stagnant product categories. It also allows the company control over the supply chain, allowing it to build on margins.

Finally, Walmart's high-margin advertising and financial services arms are also growing at a rapid pace. The company's digital ad revenue spiked by 26% year-over-year for the second quarter, topping Amazon's 20% improvement over the same period. For all of these reasons, and despite the fact that it's already up more than 50% in the last year, Walmart stock is expected to continue to rise.

Target: Price Cut Bid Pays Off

Target's second-quarter earnings marked an important turnaround for the retail giant, as it noted a significant increase in adjusted EPS and a modest 2.7% improvement in revenue year-over-year. Sales improvement was due in part to nearly 9% growth in digital sales, including online orders and those placed through the company's growing membership service, Target Circle 360.

Also key to Target's top- and bottom-line improvement has been its aggressive promotional strategy. The company has marked down prices on thousands of goods in recent months—and plans to do the same in the upcoming holiday season—in a bid to entice customers hesitant to spend money due to inflation.

The gambit has paid off, as the firm increased its free cash flow by 75% and improved both its gross and operating margins despite the move to lower prices. Target also offers buy-and-hold investors the prospect of an attractive dividend profile, including dividend yield of 2.99% and a sustainable payout ratio of 46.28%. Shares of TGT are up more than 35% in the last year.

Costco: Subscribers Remain Strong

For warehouse giant Costco, the membership model has always been a crucial factor. While this means the company can't expand into membership services in the same way as Walmart and Target, it also means that Costco customers are famously loyal; even after raising its member fees in September, the company has posted a retention rate over 90%.

On the other hand, if its customers become cautious about spending, this could limit Costco's sales and earnings growth potential. While Costco's shoppers were surprisingly resilient to the impact of inflation, the company did post lower-than-expected revenue. Still, Costco has been successful at translating revenue into profits, and it beat EPS expectations by 10 cents in the latest earnings period.

The Elephant in the Room

When it comes to retail, Amazon is the elephant in the room: most other retailers have found that it's necessary to compete on Amazon's terms in order to stay relevant. The companies above have done so to varying degrees, including developing new membership services, shifting toward e-commerce offerings, and broadening into digital ad sales and related business lines. Keeping this momentum going may be key to their continued success as the retail industry continues to become more competitive.