Wal-Mart gets its mojo back

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(Fortune) -- Wal-Mart's renewed focus on low prices is helping the retailer standout in what is shaping up to be a tough holiday shopping season.

The Bentonville, Ark.-retailer, which has waffled in past years on strategy, seems to finally have the right message at the right time, one that dovetails with the growing concerns of consumers as they grapple with slower economic growth and falling home prices.

The strategy helped Wal-Mart (Charts, Fortune 500) report a stronger-than-expected third quarter this morning (See the full story), and drove its share price up nearly 7 percent in early trading, a rare bright spot for the retailer, which has struggled in recent seasons.

Unlike last year, when Wal-Mart pushed higher priced and trendy goods in a failed attempt to attract more affluent shoppers, the company this year is playing to its base of budget-conscious consumers. At the same time, Wal-Mart, which has been battered by criticism over everything from the health care it offers employees to allegations of gender discrimination, is taking steps to repair its image.

Over the past few years, Wal-Mart found itself out of step with the broader economy, which surged largely on the boom in home prices. As a result, consumers traded up and away from the discount retailer to rivals such as Target (Charts, Fortune 500), Kohl's (Charts, Fortune 500) and J.C. Penney (Charts, Fortune 500), all of which were perceived to offer better fashion and a more enjoyable shopping experience than Wal-Mart.

Wal-Mart responded by introducing a more fashionable line of clothing called Metro7 and more expensive goods such as $1,000 flat screen TVs. But the strategy backfired, turning off Wal-Mart's core customers, while at the same time failing to attract new shoppers.

As the economy slows, Wal-Mart message of low prices is likely to resonate with consumers, at a time when many of them have seen the value of their homes decline and are likely to reign in spending. The National Retail Association predicts holiday sales will rise 4 percent, the slowest pace in three years.

"Wal-Mart typically gains share in a slowing consumer environment," wrote Goldman Sachs analyst Adrianne Shapira in a recent research note.

To that end, the company got the jump on rivals by slashing prices on 15,000 toys and other items in October. It began offering special "Black Friday" deals, like a $348 laptop computer, weeks before such promotions would normally be unveiled on the day after Thanksgiving.

Wal-Mart's low price strategy is not just hype. Shapira's monthly studies comparing prices among major retailers show a widening gap between Wal-Mart and its rivals.

The renewed focus on low prices helped Wal-Mart report third quarter earnings this morning of 70 cents, up from 62 cents a share last year -- and more than the 67 cents analysts had been expecting.

The news was a rare bright spot for the retailer, which has suffered from a multitude of problems in recent years, including slowing sales at domestic stores, allegations of discrimination and mistreatment of its workers, a scandal over the firing of its advertising chief and another one involving a senior executive accused of improperly expensing items for his personal gain.

Wal-Mart still has major challenges ahead. The company is facing saturation in the United States, and results in its international operations have been mixed. A good portion of the increased third quarter earnings came from better expense management, rather than increased sales.

To truly stabilize sales at domestic stores open at a least a year, which grew a scant 1.5 percent in the most recent quarter, the company will need to articulate an as yet undefined strategy for apparel and home goods.

For now however, the news this morning, which included higher-than expected full-year earnings guidance of $3.13 to $3.17, was enough to put Wal-Mart's trademark smiley on the face of investors.