Wal-Mart: Beyond the Bottom Line

A few weeks back I gave an overview of the retail landscape and claimed it was entering a golden era as shifts in demographics and towards online shopping created both challenges and opportunities. I also came to the conclusion Wal-Mart (WMT) one of the companies best positioned to navigate and benefit from current and future landscape.

So, with the company reporting third quarter earnings coming in slightly below estimates and the stock tumbling over $3, or some 4.2%, have I changed my bullish outlook? Not at all. It may take another day or two this news but I view this as a buying opportunity.

Here are the hard cold numbers from the latest quarter: net sales increased 0.5% to $117.2 billion, but this missed the Thomson Reuters expectation of $118.7 billion. Excluding fuel, U.S. same store sales increased 1.2%, but this missed the Consensus Metrix expectation of 1.3%. The underwhelming comps number was due to food price deflation and unusually warm weather. On the bottom line, earnings-per-share came in at $0.98 versus a $0.96 expectation. The company did raise the lower end of the range for year end guidance. Overall a mixed but slightly positive picture.

Again. I think today’s sell-off is an overreaction to company’s slight revenue miss and think it will lead to a buying opportunity. I think the $67 support level is a place to start building a long term position.

wmt-chart-11-17-16

My bullishness rests on some trends I see behind these headline numbers;

  • Online sales jumped 21%, well above the 17% estimate. For a company that does over $100 billion is sales a quarter and currently had only 1% of its sales online it portends a high level of growth for years to come. It shows its investments in Jet.com (which was only included for 6 weeks of the quarter) and Chinese online firm JDcom (JD) are paying off.

Again, I think Wal-mart is one of the few companies that will be able to compete toe-to-toe with Amazon and management has been very aggressive in building the ecommerce business. Those initiatives are just starting to payoff and have a long runway.

  • Profit margins improved 59 basis points to 13.2%. Given its scale and emphasis on discount pricing this is no small feat. The credit goes to management which had the foresight to boost employee wages and clean up the stores and inventory. This led to a better shopping experience, higher productivity, less ‘shrinkage (AKA employee theft) while maintaining competitive pricing.

Capturing the Online Shift 

Walmart is a huge company and it will take time for it to steer into its next phase but management has a clear-eyed plan to leverage its size onto the ecommerce platform. This will be key to its growth over the next decade.

More people under 35 are entering the job market than any time since 1982. With or without a recession and despite student loans, about $1 trillion US consumer spending is going to shift from brick and mortar to ecommerce in the next 10–15 yrs. Every smartphone is a potential store that’s fully in stock and never closed. Retailers who consider that to be a bad thing are insane.

This year Amazon will do about $80 billion in online sales; roughly 120% more than the next 10 biggest players combined.

Online is still only 10% of US retail sales. There hasn’t been a bigger opportunity for merchants since suburbs were invented. Other companies are going to figure out how to sell to Millennials. It’s not about competing on price alone. It’s about meeting expectations then giving a little more. Do that consistently and you gain customer loyalty, online or off. This has been true since the invention of commerce.

Smart phones in the hands of Millennials who know how to use them disrupt retail in the best possible way. Good merchants can grow right here in the US by taking share. Prices drop but margins stabilize, as happens in all new mediums. Amazon will keep their lead but not their current 30% share of the US e-commerce market. In 10 years Walmart could doing more than 20% of their US sales online.

But that’s far from saying stores aren’t disappearing. Walmart has thousands of stores. They were all built as cheaply as possible in locations near metropolitan areas. Take out the shelving and displays and an underperforming big box store can become a distribution center able to process 10x more product (and without all the shoplifting and other headaches of running a store).

Those who don’t see this installed base as an opportunity just don’t get it. Walmart is figuring out a way to combine its store base with e-commerce to offer efficient delivery, and/or pick up service that will rival Amazon terms of both convenience and price.

I’m looking at simply buying some long dated options such as the 70 calls which expire in January 2018 for about $4.00 per contract. That gives me a very limit risk and plenty of time for the stock to right itself and resume the upward path.

— Steve Smith

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About the Author: Steve Smith