Target vs. Wal-Mart: The Next Phase

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At the same time, however, Target executives "really don't want to stray too far into deep discount territory," says Morningstar (MORN) analyst Kimberly Picciola. Thus, the chain must make customers aware of the value it offers, while also boasting of better merchandise and a more pleasant store.

Even as it touts low prices, Target is planning to offer clothes designed by Anna Sui, jewelry by Anna Sheffield, and handbags by Carlos Falchi.

As always, Wal-Mart emphasizes its low prices. "There's a 'new normal' now where people are saving more, consuming less, and being more frugal and thoughtful in their purchases," Wal-Mart's Duke said. He added: "Wal-Mart can continue to attract new customers, because we're helping [the typical consumer] to do more with what she has."

Christiana's Nyheim owns Wal-Mart shares because he believes consumers will remain very careful about their spending. "We think everybody's going to be competing on price for the next year, because we're going to be in a much slower economy," Nyheim says.

At the same time, however, Wal-Mart is trying to compete in ways other than price. Consumers may have traded down to Wal-Mart for its low prices, but the chain hopes to hold onto those customers through improvements in their stores, including renovations and improved layouts.

"Wal-Mart has done a good job of reinventing themselves and cleaning up their stores," says Steven Roge, a portfolio manager at R.W. Rogé & Co.

In 2008, while the recession was at its worst point and economists were gloomy, Wal-Mart was one of the most popular stocks on Wall Street. Since March, however, investors have become more optimistic. That has helped shares of other retailers, including Target.

While Wal-Mart shares have drifted lower this year, investor expectations for Target have improved dramatically. In the past 12 months, Wal-Mart shares are down 12.7%, while Target shares are down 11.4%. Since the start of 2009, Target shares are up 28%, while Wal-Mart's stock is down 8.4%.

Much of Target's recent gains occurred on Aug. 18, in reaction to second-quarter earnings, when shares jumped 7.55%, to 44.32.

Though the two chains are fiercely competitive, it's possible that both retailers could do well. As discounters, both have a natural advantage in hard times. In better times, both could see sales rebound.

Harvey Robinson, president of Robinson Capital Group, believes the economy is recovering but the consumer will remain "exceptionally cautious."

"As the economy picks up, I believe Wal-Mart and Target will continue to benefit," says Robinson, who owns neither stock. The move of customers toward cheaper options could be permanent, he says. "Consumers are more interested in buying from discounters."

In other words, a slight recovery in the economy could be enough to get shoppers buying again. But it may not be enough to send customers back to pricier specialty and department stores.

In any environment, the competition between Target and Wal-Mart will remain cutthroat. The onus is on Target to prove it can stop the slide in sales and customer traffic. And, Wal-Mart, with its global reach and deep pockets, is not known for taking competition lying down.

Steverman is a reporter for BusinessWeek's Investing channel.

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