Sam's Club Has Potential in China

Sam's Club Has Potential in China

Wal-Mart Stores might be a top-tier option for value investors thanks to its ability to generate cash flow and return capital to shareholders, but when it comes to top-line growth, Wal-Mart has seen a very modest 1.22% gain over the past year. A lot of this has to do with a stagnant domestic market.

Of course, Wal-Mart is looking for ways to improve its top-line growth. While there are several initiatives in place, let's take a look at one in particular -- the expansion of its Sam's Club stores in China.

Because China has the largest population in the world (1.35 billion people), you would think that this move should automatically lead to exceptional results. However, if you look at retailers that have attempted to make names for themselves in China in recent years, their moves haven't gone so well, and this group includes Wal-Mart. Sam's Club differs from Wal-Mart's namesake stores, and this might be a positive for the potential of Sam's Club in China going forward.

Reasons for failures and growth potential Attempting to figure out the Chinese retail environment might seem complicated, but when it comes to Wal-Mart and Sam's Club, it's relatively simple. First, you must temporarily forget what you know about the American consumer and who visits Wal-Mart stores. In China, it's not about targeting the value-conscious consumer. The Chinese consumer either isn't going to spend much money regardless of the deals being offered or the consumer's seeing significant income gains and is willing to spend.

With that in mind, consider that approximately 10% of Chinese consumers who shop at a Wal-Mart Supercenter drive to that location. Therefore, approximately 90% of these consumers walk to a Wal-Mart Supercenter. This situation would be a positive in America, but in China, it often indicates that these consumers don't have enough money to buy cars. This then tells us that these consumers have shallow pockets and they aren't going to spend much at Wal-Mart, regardless of low prices. This is also one of the reasons why Wal-Mart plans on closing 15-30 Wal-Mart locations in China. However, Wal-Mart still plans on opening 110 new namesake stores, as it now sees itself as more educated on the Chinese retail landscape and consumer.

The good news, or at the least potentially good news, is that approximately 90% of customers who shop at a Sam's Club drive to that store. Therefore, these consumers have deeper pockets than most consumers who visit Wal-Mart stores. Sam's Club is also now focusing on more suburban locations, which doesn't just equate to the targeting of wealthier consumers, but also means lower rents.

You might think that consumers who require a car to visit a store won't shop as often as those who can walk. You would be correct, but ... most Chinese consumers who visit Sam's Club stores shop for the entire month. This means much larger basket sizes. They don't always calculate correctly, sometimes overestimating how much they will need.

Another advantage for Sam's Club stores in China is that they carry many imported products that local stores don't offer. The company expects the value of these imported items to increase five-fold this year.

As of right now, there are just 10 Sam's Club locations in China, but two of the three most successful Sam's Clubs are in China. Therefore, it makes sense that Wal-Mart plans to open two new Sam's Club stores in China per year, and plans to increase this to 10 new stores per year within six to seven years.

Staying out One key advantage for Sam's Club in China is that it doesn't have to compete with Costco there. In an interview with Motley Fool contributor Austin Smith, Costco CEO Craig Jelinek stated that the company has no interest in entering the Chinese market right now. He gave several reasons for this decision. One, he has seen many other U.S. retailers go to China and struggle, citing this as a red flag. Two, Costco is doing well in other Asian countries, including Taiwan, Korea, and Japan. Three, Costco plans to focus on expansion in France and Spain. Four, Costco doesn't want to stretch its management too far. Sounds like a sensible CEO to me.

Wal-Mart's namesake stores also don't have to compete with Target in China. Target is instead focusing on Canadian expansion, which up until this point hasn't gone as well as expected. The economy is highly likely to remain global, and if Wal-Mart continues to establish its presence in international markets ahead of Target, then it will learn through trial and error much faster than Target and gain a good head start on one of its biggest rivals. That's if Target aims to expand further, but this should eventually become a reality as not many retailers can deliver sustainable and impressive growth in domestic markets forever. New lands must be explored.

The bottom line Wal-Mart might only have 10 Sam's Club stores in China at the moment, but this should be seen as a positive, especially because the company plans to add more strategic locations and two out of three of the brand's most successful locations are located in China. As of right now, Sam's Club China isn't a big factor in the overall company's results, but the point is that this is one area where Wal-Mart has strong growth potential. Given the size of Wal-Mart, it isn't easy to find such opportunities.

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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