Food retailing companies would do well to invest the coming benefits of tax relief into sharper pricing and better service—and may not have a choice in the matter if Walmart and Costco do the same, an analyst said in a new research report.
The latter companies, given their current momentum and large sales volumes, stand to benefit the most as a result of the sweeping tax bill, said Barclays analyst Karen Short in a research report issued to clients Friday. According to Short, those companies are also likely to deploy their additional cash offensively, and as a result force smaller competitors to do the same. That could slow the pace of EBITDA growth and slow merger activity in the food retailing space as companies direct cash to capital spending—and less of the benefit to debt reduction and shareholders—in an attempt to keep up.
“In our view, Walmart and Costco will reinvest a significant portion of the incremental dollars, and as a result … we believe a decent portion of the excess cash is likely to get arbitraged away,” Short said.
Walmart is already enjoying the benefits of out-investing its supermarket rivals in recent years, turning around sluggish sales behind billions of dollars in investments in lower prices, employee salaries and training and digital initiatives.
The new tax code approved last month will slash federal corporate tax rates and increase the amount of deductible capital expenditures, changes that will dramatically increase free cash flow. According to Barclays’ estimates, Walmart could realize about four times the incremental cash-flow benefits of its nearest competitor among the publicly traded retailers covered by Barclays.
“Tax reform presents a significant opportunity for mediocre and weaker retailers to proactively strengthen their competitive positioning,” Short added. “We firmly believe if they ignore this opportunity … then they will only exacerbate their weaker position.
“For retailers that do reinvest in their business, the degree of flow-through from tax reform will ultimately depend on Walmart—and to a lesser extent Costco—specifically, if Walmart communicates that it plans to reinvest a significant percentage of its savings then we believe the competition will be forced to react accordingly.”
Short noted her prediction of active reinvestment in the business is more likely for food retailers than for foodservice operators Barclays covers. That’s due to the relative lack of price transparency in the restaurant business and the underlying trend toward consumers spending more in that channel.