An industry analysis: Discount variety stores

1. An industry analysis:Discount variety stores By aileen huang, Kate Johnson, Jennifer Kellner& claire lin

2. agenda • Introduction, Summary Statistics, Industry Overview • Company differentiation • Industry & Assumptions • Detailed Earnings Analysis • Valuation Methodology • Final Valuation, Recommendations • Conclusion

3. Introduction:Valuation statistics & the industry • Competitive • Drivers of profitability in the industry • Macroeconomic conditions • Effective asset use (EATO) • Margins (EPM) • Sales per square foot • Mobile and online sales • Each company offers low prices, added value • But different models, differentiation factors reduces comparability (see above) • Ex: Costco

4. introduction:Valuation statistics & the industry • Macroeconomic conditions strongly influence the industry • The Financial Crisis of 07/08 • Industry volatility • But also a shift in profitability across stores • Drives market share

5. Consists of more than 11,000 retail units in 27 countries within 50 states • Targets low to medium income families • Value focused rather than brand directed • Provides convenience of one stop shopping with a low-cost “no frills” warehouse store • Builds the loyalty of customers through “Everyday Low Price” • 3 operation segments including U.S domestic, International and Sam’s Club • Opportunity for shoppers to shop online • Greatest coverage amongst all of the retailers, low operating costs, and influences the discount retail industry immensely

6. Adds value through low prices but distinguishes itself from other discount retailers through its perceived higher quality both in brands carried and store layout • “shopping experience” • Generates revenue through its general store, café, clinic, pharmacy, photo, and leased and licensed departments • 40 distribution centers, 37 in the Untied States and 3 in Canada • Recently expanded into Canada • Employees “team members” and customers “guests” • Reputation for treating both its employees and guests very well, both through added benefits and customer service • REDcard (Credit and Debit reward cards) also promote loyalty amongst guests • Very focused on innovation and constant improvement, currently focusing significantly on its online and mobile shopping experience

7. Largest discount retailer in the US by number of stores • 11,215 stores in 40 states • Key items of high quality national brands from leading manufacturers and comparable quality private brand selections with prices at substantial discounts • Merchandise typically $10.00 or less • Convenient “in-and-out” small-box locations with selling space averaging approximately 7,400 square feet • November 2009 common stock became publicly traded • Delivers both value and convenience and succeeds in both small markets with limited shopping alternatives and large markets, coexisting along larger retailers • Stores conveniently located in a variety of rural, suburban and urban communities, approximately 70% serving communities with populations of fewer than 20,000. • Majority of customers live within three to five miles, or a 10-minute drive, of its stores • Close proximity drives customer loyalty and trip frequency • Attractive alternative to large discount and other large retail and grocery stores located far away

8. Consists of 71,200 members and offers large volumes of merchandise at low price • As of fiscal year end 2013, operated 451 membership warehouse clubs in the United States, 85 in Canada, 32 in Mexico, 22 in the United Kingdom, 13 in Japan, 9 in Taiwan, 8 in Korea, and 3 in Australia • Customers must pay a membershipfee in order to purchase products • Less labor, warehouses, and better inventory management • High turnover of inventory • Because Costco buys a majority of their merchandise directly from manufacturers, they use containers for shipping and get a lower price • Instead of using traditional multiple-step distribution channels, Costco uses a cross-docking consolidation point for distribution to increase the asset turnover ratio and reduce the labor costs • Inventory is funded through payment terms • Targets college-educated households • Costco lays its inventory out through stacking its products in high structures throughout the warehouse and therefore has a much higher profit per square foot than other discount retailers as a result

9. INDUSTRY ASSUMPTIONSSales Growth • Life cycle stage: Mature/Declining • Competitive in U.S. market • Expand internationally • Wal-Mart • Mature • Target • Recovery from data breach • Ambitious expansion plan in Canada • Dollar General • New Dollar General Market • Costco • Fast expansion, 25-40 global warehouses openings

10. EPM & EATO • Very stable • Steady status: 2017-2019 • Business models • Target customers • Different EPM&EATO combination

11. Profitability Map: Wal-Mart • Mature • Steady state • Low risk

12. Profitability Map: Target • Presence in Canada, higher margin • Investment in computer software & equipment

13. Profitability Map: Dollar General • Increase in fresh food categories, which have the lowest margin • Renovation, opening, and expansion of many stores

14. Profitability Map: Costco • Stable • 2013 Translation of foreign currencies • Increase presence of its private brand • Better working capital and inventory management

15. Earnings Analysis • Are historical earnings comparable? • Inventory • Operating lease • Stock-based compensation • Inventory • Target and Wal-Mart use RIM to approximate LIFO, no LIFO Reserves are provided to adjust NEA and EPAT • No large impacts on EPAT but such adjustments will lead to improved forecast

16. Operating Leases • Dollar General has significantly more operating leases: higher financial leverage • Share-based Compensation • These adjustments will impact both EPM and EATO

17. Earnings Analysis • How current earnings can be expected to relate to future earnings • International Operations: 29% of Walmart’s revenue comes from international operations • Online Segment: companies have different levels of online presence • Target data breach Effect of acquisitions • Target acquired DermStore Beauty Group, Chefs Catalog, and Cooking. com in 2013 • No material impacts on Target’s 2013 financial reports • Those transactions may bring strategic growth opportunities

18. Valuation Methodology • Multiple valuation approach is not adopted as each firm has different business models • Which valuation model to apply (FCF, REI or AGR) • Valuation result will not be affected • REI model anchors on the current year NEA • The discount variety store industry is capital intensive, NEA is critical to the profitability of each firm

19. Valuation Methodology: REI Residual enterprise income explains the premium of market value over book value

20. conclusion:final recommendations • Value-to-price ratio determines rank • Wal-Mart, expect price to go up slightly (Ranks #1) • Others, expect slight decrease • Costco – more significantly overvalued by the market • Overall, fairly accurate market valuation

21. conclusion:the industry • As a whole • Expect industry to suffer • Saturated market; high competition • Online sales, e-commerce • Less capital intensive, taking significant market share • Nevertheless, industry will remain ongoing • Physical stores will always be in demand • Suffer but mostly follow the macroeconomic trend • Consider other investments available in the market • Consider related industries • Amazon, eBay

22. Questions?

23. Appendix

24. Profitability Analysis (ROE Breakdown) • Most of Target's ROE is driven by profitability of the firm, RNEA • Target is not getting much of a return from leverage, about 0.43%. Leverage is not concealing poor performance. There could be the potential to use greater leverage, however. • - Wal-Mart is generating a lot of ROE by employing debt; almost half • Costco also generates most of its ROE from enterprise operations.

25. Dollar General

26. Target

27. Costco

28. Wal-Mart

29. How are they profitable? • Convenient Locations • Time Saving Shopping Experience • Everyday Low Prices on Quality Merchandise • Key items in a broad range of general merchandise categories • Most basic shopping needs are met in one trip

30. But DG is a Dollar Store? • Dollar General is more suited to be compared with Walmart, Target, and Costco, as not everything is $1 (DLTR) and DG has started to carry produce in many DG Markets (unlike FDO)

31. Store Growth • 2011-2012 Growth: 5.72% • 2012-2013 Growth: 5.96% • DG is a February 2 year end 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . 10,506 650 24 626 11,132

32. Expect to open 700 new stores in 2014 • Remodeled and expanded 582 stores last year