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By Ken Perkins, CFA | 05-20-2015 02:00 PM

Wal-Mart vs. Target: Which Is More Attractive Today?

Target might perform better in the short term, but Wal-Mart's ability to drive returns on invested capital gives it a long-run advantage.

Securities mentioned in this video
WMT Wal-Mart Stores Inc
TGT Target Corp

Ken Perkins: We think that Wal-Mart (WMT) is more attractive than Target (TGT) at current valuation levels. The two companies are very similar in many respects, but we think that there are a few key differences that investors should know. The first is that we give Wal-Mart a wide economic moat, but we do not assign Target an economic moat.

There are typically two sources of moats in retail: One is pricing power and the other is cost advantage. Firms that have a cost advantage tend to have above-average store productivity and below-average margins, whereas firms with pricing power tend to have above-average margins and below-average store productivity.

If you look at Target, the retailer has above-average margins and below-average store productivity, suggesting that it may have pricing power. However, we think that Target's above-average margins are more reflective of its product mix than of pricing power itself. This is important because competition is increasing in many of Target's categories, and we think that, over time, investors should note that its margins could come under pressure.

That said, we think that the company's long-term strategic priorities--such as omnichannel retailing, urban formats, and cost-cutting--should help it defend itself against increasing competition.

We think that Target is priced not only for a turnaround, but also as though it's a wide-moat retailer. The company's results should outpace Wal-Mart's over the next couple of years; but over the long term, we think that Wal-Mart has a much stronger ability to drive returns on invested capital above cost of capital. We think this is what makes Wal-Mart more attractive than Target at current levels.

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