After successfully converging online retail with traditional brick-and-mortar retail, Walmart Inc. (WMT, Financial) seems to lack a strategy to sustain growth, as evidenced by two red flags that rose last week.
The first red flag is the company's decision to partner with an outside firm to offer next-generation digital financial products to its customers.
Apparently, this move is outside the retail giant's "core" business and sounds similar to Sears' decision to set Dean Witter retail brokers to its stores back in its old glory days.
Quo Vadis Capital President John Zolidis, a long-term Walmart follower, doesn't think that selling digital financial products will have any material impact on its top and bottom line. He is further concerned about the company venturing away from its core businesses.
"Among the reasons we are not keen on WMT shares is our sense that WMT is deviating from its capital allocation discipline and core competency," he said. "We see WMT's pursuit of TikTock, venture capital plays in India, the launch of a subscription delivery program, attempts to become a healthcare provider, acquisitions and divestitures of various digital brands, and now this foray into "next-generation digital financial products" (we hope this does not mean bitcoin) all to be tangential to the core business."
Zolidis rightly points that 24% of Walmart's customers do not have a bank account, and likely half of its customers do not have access to credit.
"Without being judgmental, we imagine the reasons these customers do not have bank accounts or credit would likely also mean they will have little use for "next-generation financial products," he added.
Meanwhile, another red flag rose last week with the departure of Marc Lore, the chief architect of the company's e-commerce strategy, which helped the retail giant successfully join its traditional retail business with online retail.
"We view Mr. Lore's departure as an incremental negative in that it removes a visionary and entrepreneurial executive from the company," Zolidis said. "It could also indicate that a shift in direction concerning omnichannel or digital strategy is coming, which will be less focused on aggressive moves to drive revenues at the expense of profitability."
Still, there's another explanation for Walmart's recent moves. The retail giant may be running out of profitable opportunities, as evidenced by a narrowing of its economic profit in the last couple of years prior to the Covid-19 pandemic.
Economic profit is the difference between the return on invested capital and the weighted average cost of capital. It is a measure of a company's competitive advantage and an indication of how effectively management deploys capital. A declining economic profit signifies one of the three scenarios, the company's ROIC is falling, its WACC is rising and a combination of both.
Walmart's economic profit was falling prior to the Covid-19 pandemic. That could mean the retailer's exploitation of profitable opportunities and competitive advantage may be undermined by the rise of competitors like Costco (COST, Financial) and Target (TGT, Financial), which have experienced a rising economic profit (see second and third chart).
Walmart's Economic Profit
Costco's Economic Profit
Target's Economic Profit
While it is still unclear whether a move into non-core business and the departure of a key executive signals a big problem for Walmart's strategy, one thing is clear: As Walmart gets bigger and bigger, it will become more difficult to deploy capital as effectively as in the early days when it had plenty of room to grow at home and abroad, below the radar of competition.
Disclosure: I don't own any shares of Walmart.
Read more here:
- Target Rides the New Trend in Retail
- Intel: A New CEO and Old Problems
- How Zoom Can Maintain Its Edge Against Microsoft
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
