Citi Responds To Clients' Complaints Following Initiated Coverage Of Wal-Mart, Costco And Target

Citi's Kate McShane recently began coverage of Target Corporation (NYSE: TGT), Wal-Mart Stores, Inc. (NYSE: WMT) and Costco Wholesale Corporation (NASDAQ: COST).

McShane added that the stocks are "highly controversial," as many of the firm's clients questioned the analyst's findings.

The analyst addressed the most common concerns and questions raised by the firm's clients.

Retail investors have faced a tough 2015 as few companies sufficiently impressed investors to justify a multiple expansion. Citi's retailing analyst Kate McShane initiated coverage of Target, Costco and Wal-Mart earlier this month, and through her own admission in a note on Tuesday, the stocks are "highly controversial."

Here is a summary of Citi's customers top concerns and the analyst's answers.

Target: Margins, Capex Pressure, Valuation

Concern: Why is Target better shielded from wage issues compared to Wal-Mart?

Target's employees have a higher productivity (EBIT per employee) versus Wal-Mart and the company is "more protected" from an incremental $1 per hour increase.

Concern: Why doesn't Target have to invest heavily in e-commerce?

Target is investing in "how customers choose to shop," including the new small box formats (City Target).

Concern: What will Target's growth margins look like in 2016?

Target's margins in 2016 should improve year-over-year due to an improving sales mix from Signature, City Target and a more optimized inventory. At the same time, a drag from the increase in Digital will diminish over time as the company gains scale in e-commerce.

Costco: Credit Card Concern

Concern: Could the credit card switch cause a disruption?

Costco's switch to a co-branded Citi card (from American Express) will create royalty revenue from purchases outside of Costco's stores and benefit Costco from a yet-to-be-announced loyalty rewards program. As such, any impact from the switch will be "minimal."

McShane also noted that Citi is expected to purchase American Express' portfolio of U.S. Costco accounts, which will allow the bank to issue new Visa cards and facilitate the transition with little to no disruption expected

Wal-Mart: Why Can't They Just Win Based On Scale

Concern: Doesn't Wal-Mart's sheer size and scale make it the winner by default?

According to McShane, despite Wal-Mart's size, the company still has to undertake "significant" investments. In addition, approximately 50 percent of planned capital expenditures is being allocated to stores – a proportion that may be "too heavily weighted" and could "prolong" its ability to "make further strides" in its omnichannel efforts.