Wal-Mart (NYSE:WMT) excels in terms of its established store exposure and its attractive pricing. But with rapidly changing shopping habits, many question if WMT will be able to compete with the likes of Amazon (NASDAQ:AMZN).
At the moment, WMT seems to be fully engaged in pursuing an e-commerce strategy that is weighing down the company’s margins and operating income. However, as it works towards strengthening the digital wing of its business model, we could see the pressures ease off on both metrics. The results are likely to boost not only e-commerce revenues but also positively impact profitability in the long run.
I believe that these digital initiatives and investments have the potential and capability to challenge e-commerce giants in the long term, possibly making WMT a dominant name in the e-commerce space as well.
WMT posted its second-quarter results on 17th August, 2017. There are a few points that caught my eye in these results.
Firstly, the 2.9% YoY increase in sales and the 20 bps YoY increase in comparable sales indicate that WMT seems to be holding up quite well despite the surge in e-commerce shopping trends. E-commerce revenues reported a 60% jump during the quarter. I view this as a sign of the company performing well in terms of in-store and online sales. I foresee that this trend of reporting healthy sales numbers across the board is likely to continue throughout the year.
Another important takeaway from the recent results was the healthy comparable sales guidance estimated by WMT. The retailer expects comp sales to clock in between 1.5% and 2% for the full year. This indicates that the company is confident that sales will continue to look up amid changing shopping dynamics.
It appears that the retailer’s strategy of acquiring e-commerce companies seems to be paying off. I have used a comparison of e-commerce growth rates reported in the past to the recently reported results. Growth in e-commerce sales has significantly scaled up from ~27% in the beginning of 2014 to 60% that was recently reported. The trends clearly illustrate acceleration in the pace of sales growth. This signifies that WMT is beginning to make headway as the benefits of its acquisitions and other efforts begin to be realized in financial terms.
The dip in operating income (by 1.6%) and the margin contractions (from 5.1% to 4.9%) reported by WMT during the quarter disappointed investors. Since 2013, we have seen operating expenses increase to the tune of ~14.6%. However, I believe that the increase in operating expenses is due to the scale up in digital investments. WMT, on a previous occasion, had estimated that it would take about two years for the investments to pay off and reduce the downward pressure they are exerting on the company’s bottom line. Hence, we should expect these low margin and profitability trends to continue throughout 2018. Going by WMT’s estimated time frame, we could begin to see improvements in margins and incomes after 2018. My personal view on the operating expenses is that the growth is not something that will continue in the long term. I view it as current expenditure that is being used to build permanent streams of future income through digital and e-commerce channels. As the permanent streams of future income develop themselves and begin contributing more towards revenues, we would possibly see a decline in operating expenses.
As I move on to the company’s balance sheet, I see that cash was reported at $6.47 billion for the quarter. Previous balance sheet results indicate that WMT prefers to hold cash balance between $5 and $10 billion. The current ratio of the retailer equates to 0.78, which is close to the current ratio levels maintained during the 2008 recession. WMT’s ability to maintain a ratio close to recessionary levels possibly insulates it from any liquidity problems that could arise in case of an economic downturn.
The industry shift
The Food Marketing Institute and Nielsen recently published a report on the growth of online grocery shopping taking place. It is estimated that nearly 25% of Americans currently engage in shopping for grocery online. This number is expected to witness an increase as more than 70% of Americans will opt for shopping online within the next decade. From this, it is the millennials who are expected to be actively participating in online grocery shopping going forward.
Source: Food Marketing Institute and Nielsen
The report stated that:
“Only the retailers that first develop an understanding of their digitally engaged shoppers, build a strategy around that understanding and cost-effectively integrate digital food retail into their banner and channel promise will be market leaders.”
What can be understood from this statement is that it is the current brick-and-mortar retailers that are better positioned to benefit from this growth as they can leverage their existing assets with digital functions.
This is a positive indication for WMT as the giant currently operates close to 5,000 stores and clubs across the US. Besides its substantial footprint, the retail giant also offers customers a variety of products at attractive prices. But that is just the competitive advantage that this big name has for its brick-and-mortar business. Behind the scenes, WMT is engaged in several initiatives on the digital front which could put it in a better position to win a seat at the e-commerce players’ table in the future.
Wal-Mart’s e-commerce initiatives
It is no secret that WMT has not stood still in response to rapidly changing shopping dynamics. We have seen the retailer get involved in multiple e-commerce acquisitions. There are also several efforts that are taking place within its business as it works towards building its digital presence and product and services portfolio.
Nearly 30% of millennials in the US have shopped for groceries online. 60% of these online purchases have been delivered to doorsteps while 26% were store pickups. One of WMT’s initiatives includes expanding the capabilities of the walmart.com platform to cater to these shopping habits of millennials. Through this, WMT allows customers different options such as ship to home and store options as well as pick up options.
The company is also looking into the idea of offering steeper discounts on shopping from walmart.com – a complex pricing strategy that it picked up from its acquisition of Jet.com. The free two-day shopping for purchases over $35 attempts to mimic the Amazon Prime model, but without the annual fee. This is what is believed to have fed the 60% growth in e-commerce sales that were witnessed during the latest quarter.
The company is also involved in experimenting with new services like testing the in-home delivery of groceries to customers as well. Besides this, the retailer has installed automated kiosks in approximately 100 stores to provide a convenient shopping experience for in-store customers. The retailer is focusing on making brick-and-click work for it as it recently collaborated with Google (NASDAQ:GOOG) (NASDAQ:GOOGL) to launch an online shopping mall, Google Express.
Considering that the holiday season is just around the quarter, I foresee that the contribution of these initiatives will begin picking up momentum as they gain more popularity with shoppers. With the possibility of discounts on larger online orders and better rates for shipping, it is possible that WMT will be able to deepen its price advantage by offering them on its e-commerce platforms. In the interim, the benefits of these initiatives could be seen contributing in terms of higher e-commerce sales growth in the next two quarters of the year.
WMT is overvalued
I believe that the stock is overvalued at current price levels making it an expensive choice for an investor’s portfolio. I say this because of two reasons. Firstly, the stock currently trades at a PE of 19.05, which is significantly above its five year average PE of 15.42. Secondly, my calculation through the constant growth dividend discount model calculates the stock value at $68, which is significantly above its current price level of ~$79.
Data Source: Morningstar Financials
Nevertheless, I believe that as the e-commerce investments begin unleashing their potential, there will eventually be significant upside in the price of the share. If we evaluate the stock by its current PE valuation, it definitely is expensive. However, it is important to note that earnings are weighed down by the high levels of operating expenses which are not sustainable at such high levels in the long term. It is important for investors to remember that although WMT hasn’t reported massive increases yet, its long-term prospects are promising. I am confident that as the payouts of these investments begin gaining momentum, the company will be able to report healthy top and bottom line growth. These growth prospects support a bullish view on the stock.
What we need to realize is that the current digital investments that WMT is engaged in may take time to materialize. The recently reported results prove that WMT does seem to be making headway as it reports phenomenal increases in its e-commerce sales numbers. I am confident that the retailer’s attempts to make progress in the e-commerce industry will result in sales increases. This would ultimately also lead to increases in profits.
The stock currently trades at $79.29. For those who are interested in an investment horizon of 2-3 years or more, I would recommend a long position in WMT as I see the stock crossing the $100 mark within the next 2-3 years. The stock also has a decent dividend yield of 2.55% per share, so investors could also benefit from dividends as they maintain their long positions. I view any weakness in share prices as an opportunity to accumulate.
Let me know what you think about WMT and its digital initiatives. Leave your thoughts in the comments section.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.