Here's why the biggest retailers are crushing smaller chains in a tough economy

By Bill Peters

Walmart has essentially fashioned itself into 'Amazon 2.0,' one analyst says

In the second quarter, Macy's Inc. (M) said its shoppers, still deep in the fight against inflation, grew more cautious.

At Urban Outfitters Inc. (URBN), things were tough enough that executives said the company would turn away from its "traditionally alternative sensibility" to be more welcoming.

Even dollar-store chains Dollar Tree Inc. (DLTR) and Dollar General Corp. (DG), which tend to do well when customers get spooked, both cut their financial forecasts - with the latter noting most of its customers felt "worse off financially."

But at Walmart Inc. (WMT) - which, of course, is also a big discount chain - the narrative was far different.

"So far, we aren't experiencing a weaker consumer overall," Chief Executive Doug McMillon said during the retailer's earnings call.

With the latest round of quarterly results largely in the books, the retail industry has increasingly become a story of the biggest mass retailers, like Walmart and Costco Wholesale Corp., and everyone else.

In a recent note, BNP Paribas analysts specifically cited Walmart, Costco and Amazon.com Inc. (AMZN) as exceptions in saying, "Most retailers ... are struggling to show growth."

Some analysts say that a consumer shift toward the biggest chains capable of offering better deals, in an effort to relieve inflationary stresses, could turn into something more permanent, as years of investments in technology and e-commerce by those retail giants have started to pay off.

"We think that it's very likely that the behavior shifts that are currently underway by Walmart customers are going to prove much sticker than we've seen during other points in history where Walmart has had what might have been a more temporary, cyclical benefit," KeyBanc analyst Brad Thomas said in an interview.

Thomas said Walmart, after years of expansion, was finally big enough for its online shopping and delivery infrastructure to start working for customers. He cited benefits including the rollout of Walmart's app, its membership program, its store remodels, its "elevated" clothing selection and its new Bettergoods food line - a gesture toward more upscale consumers that Walmart has described as "chef-inspired" and "trend-forward."

"In a nutshell, what Walmart is doing is it's built basically Amazon 2.0 on the rails of the network of Walmart," Thomas said.

The analyst added that Walmart's recent investments would make it more attractive to wealthier customers, more of whom have flocked to the chain looking for ways to save money. Still, those customers can afford to be more fickle, and there's no guarantee they'll stick around, he said.

Moreover, Walmart has leaned heavily on groceries, which people have to buy, for its sales. Sales in general merchandise - generally things that aren't groceries, like clothing and electronics, where demand has suffered thanks to higher prices for essentials - got better during the chain's second quarter. But overall, they were still "relatively flat," the company said.

However, at Costco (COST), executives recently raised membership fees for the first time in seven years, after demand held up through the pandemic and through two years of broader price increases. Oppenheimer analysts recently said the chain's sales in August were a testament to its ability to navigate the shakier consumer landscape. Costco reports its quarterly results on Sept. 26.

"In the recent mixed discretionary backdrop, we believe [Costco]'s merchandising efforts, including an attractive assortment of discounted gift cards, have contributed to a meaningful improvement in nonfoods category trends lately," the Oppenheimer analysts wrote in a research note.

"We expect strong top-line momentum to persist for the balance of the year, driven by the company's superior merchandising prowess and its unique value proposition," they continued.

Even recent results from Target Corp. (TGT) - which sells more of the things people don't have to buy, and has struggled because of it - showed signs of a turnaround. Same-store sales for clothing were up during Target's most recent quarter, and discretionary categories overall improved.

"It shows that the mass merchants are key destinations for consumers during this period of stress," UBS analyst Michael Lasser said in a recent note. "The consumer can capitalize on compelling values, find new and innovative products, and consolidate trips. We see no reason why this trend should end any time soon."

Further downstream, where expectations have been subdued, investors have still found things to like. Initially, they liked the results from Gap Inc. (GAP), Victoria's Secret & Co. (VSCO) and Nordstrom Inc. (JWN), even though Nordstrom executives are staying conservative on the months ahead. Five Below Inc. (FIVE) tempered its plans to open new stores, but markets at the time didn't seem to mind. However, shares of Oxford Industries Inc. (OXM), the parent of Tommy Bahama, took a hit after the company cut its outlook.

The gains for chains like Walmart and Target could raise bigger questions about the divide between massive retailers and smaller businesses. And some analysts say Walmart's advances have translated to setbacks for rival dollar outlets and smaller convenience stores.

Dollar stores sometimes try to position themselves near Walmart locations with hopes of peeling off shoppers making "fill-in" trips, where they only pick up a handful of things. But KeyBanc's Thomas said that along with the more pronounced struggles for lower-income customers, Walmart's e-commerce business has also taken away some shoppers who would otherwise go to the dollar stores.

"We believe the dollar-store business has gotten to be a little bit more discretionary in recent years than it used to be 20 years ago, when it was a bit more about necessity," he said.

Nikki Baird, vice president of strategy and product at retail tech firm Aptos, pointed to other things that may have separated the winners from the losers during the quarter.

"Winners took a more aggressive stance on promotions and discounts, catering to back-to-school shoppers," she said over email. "Whether they were discounting more heavily or not, they worked to create a perception of deals."

Smaller touches - emphasizing back-to-school items over clothing, and spacing out aisles and shelves to accommodate family-sized groups - also helped, she added.

Now, customers, and Wall Street, will turn their attention to the key holiday shopping season - the start of which, once largely delineated by Black Friday, has melted over into the early fall. Discount clothing retailers like Temu and Shein, as well as social-media platform Tiktok, are expected to play a bigger role this year as the search for deals gets more aggressive.

TikTok's first foray into the summer retail-deals frenzy may have stumbled, by at least one analyst account. But as the year-end shopping season kicks into gear, some analysts expect the platform to pose a bigger challenge to larger, deeper-pocketed retailers and smaller ones alike.

"TikTok is investing heavily in its shop features, including restructuring its affiliate marketing program to encourage more users to be shopping influencers," Caila Schwartz, director of strategy and consumer insights at Salesforce, said over email.

That strategy, she said, was showing signs of working. The number of customers who said they bought something on TikTok has jumped by 24% since April, according to Schwartz.

-Bill Peters

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09-14-24 0710ET

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