The Ratings Game: Walmart takes on dollar stores with lower prices

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Walmart Inc. is taking on dollar stores in the area where they historically have been most competitive — price.

Big Lots Inc. BIG, +1.43% , Dollar General Inc. DG, +0.30%   and Dollar Tree Inc. DLTR, -0.06%   were all downgraded at Raymond James on the renewed threat from Walmart WMT, +1.28%  , with analysts suspecting that the retail giant is focused on price.

“During the past year, pricing for Walmart and Dollar General has been relatively in line,” analysts led by Dan Wewer wrote in a note. “Our latest survey provides evidence that Walmart is reinvesting some of its tax savings into pricing as part of an effort to grow market share.

Raymond James’s survey found that Walmart’s pricing for consumables, which includes laundry detergent and cereal, is 4.4% lower than Dollar General and 6.5% lower than Family Dollar, which was acquired by Dollar Tree.

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“We are finding the prices for the Walmart basket declined 3.8% from February 2018 through April 2018, led by reductions for traffic generating products such as Cheerios (-42%), Heinz Ketchup (-14%) and Old Spice Body Wash (-24%),” the note said.

Analysts also highlight comments from the companies, with Walmart saying at a Raymond James event that it would use tax overhaul benefits to enhance price investments, while the dollar store retailers said they would invest in pay, benefits and digital upgrades.

Raymond James says the price gap “is not yet alarming” for Dollar General and Family Dollar, however it does increase risk.

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“Consequently, the value retailers now face a conundrum that certainly dampens out bullish investment themes for the sector,” the note said. The value retailers will have to lower their prices, which could hurt margins, or promote their convenience versus Walmart, “which could become a comp sales headwind over time as consumers eventually take notice of Walmart’s stronger value offering.”

Despite the bearish outlook, the downgrade for all three value retailers is from outperform to strong buy.

“The reason why we are not lowering the investment rating to market perform is that our ‘company specific’ investment thesis for each retailer remains bullish and the valuation metrics remain below historical averages,” the note said.

Dollar General’s price target was cut from $110 to $105, Big Lots’ price target was slashed to $48 from $60, but analysts maintained their $110 price target for Dollar Tree.

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Earlier this month, Credit Suisse analysts noticed accelerating price investments at Walmart.

“Private label continues to drive mass channel unit share gains, and seem to be the main focus for price investments,” analysts led by Seth Sigman wrote in a note.

“While we wouldn’t overly rely on this data as an indicator for overall comps, it could suggest U.S. revenue growth in the 3% range, consistent with current estimates and slightly below the 3.4% growth in Q4, depending of course on the performance of non-grocery categories and e-commerce.”

Credit Suisse rates Walmart shares neutral with a $102 price target.

Walmart shares are down 12.1% for the year so far, while Big Lots shares are down nearly 25% for the period. Dollar Tree is down 9.9% and Dollar General is up 3.4% for 2018 to date. The S&P 500 index SPX, +0.64%  trades at nearly breakeven for the year to date and the Dow Jones Industrial Average DJIA, +0.79%   is down 1.5%.