Walmart (WMT, Financial) stock has declined more than 11% this week.
The stock's decline is due to recent growth projections from Walmart’s 22nd annual meeting for the investment community.
With stock declines of about 10% the day of the meeting, things did not go well.
For some companies (Netflix [NFLX], Amazon [AMZN], Tesla [TSLA], Facebook [FB], etc.) revenue is all that matters (to the investing community). Profits are a distant thought – something that can be achieved one day, after rapid revenue growth is achieved.
Walmart is not judged like those businesses. For Walmart profit matters. That’s a good thing for investors and for Walmart.
After all, Walmart is a Dividend Aristocrat with more than 40 years of consecutive dividend increases. You can’t do that unless you focus on profit.
Unfortunately for Walmart, most investors are focused on short-term growth: What can you show me over the next quarter or year?
Walmart could have continued on the path it has been on for the last decade – building new stores, finding new ways to cut costs and repurchasing shares.
Walmart’s reputation was slowly declining. The company was not seeing significant comparable store sales improvements. Instead of continuing on the same path, the company is repositioning itself.
Here’s what Walmart CEO Doug McMillon had to say about the company’s strategy in its recent investor meeting (emphasis added):
“So today, we’re older than 50 and we’ve become large and if you study retail history you know that retailers come and go, and we’re going to defy that historic cycle that retailers go through by being thoughtful enough about how we position ourselves for the future and embrace change and be willing to cannibalize ourselves if we need to be so that we can set the stage for the future.
And yes, that’ll put some short-term pressure on the company but we believe that you and others will support it as long as you understand the strategy, you know why we’re doing it and we do a sufficient job of answering your questions about it.
So we’re going to invest a bit less than we would have in stores. We’re going to invest more in ecommerce and overall the capital range that Charles is going to share with you a little later today will be slightly lower than last years but with a mix difference towards more ecommerce dollars.
In previous years, you’ve heard us speak to the financial priorities of growth, leverage and returns and I want to clarify where we are right now because we are in this period of transformation. As we pivot towards the future, growth is our top priority. If we’re not relevant for customers, nothing else matters.
So we’re always going to work to achieve leverage. You don’t have to worry about us putting processes in place that make us more efficient or watching our travel costs. We just do that habitually. We will manage cost but the best way to deliver leverage over time is by growing sales.
These things have to work together. You want growth and returns. So do we. But for now, growth is our focus. Our core business will continue to have great returns and we believe the investments that we’re making in ecommerce will help returns over the long term. And don’t just think of those investments as being pure ecommerce but also have this mindset around how the whole thing comes together.”
Walmart’s plan
Walmart’s management believes it cut costs too hard in the United States – which has resulted in unmotivated employees and a less-than-stellar reputation.
The company’s plan is to grow revenue through improving customer experience. This includes:
- Better motivated employees
- Online and in-store seamless experience
These two experience improvements are costly and will reduce margins. They also set Walmart up for another long run of growth.
Customer experience scores are already improving, as the image below shows:
Source: Walmart 22nd Annual Meeting Presentation, slide 4
Digital sales are growing rapidly for Walmart. The company is expecting digital growth of between 20% and 30% a year.
The company’s digital operations are currently unprofitable,and are projected to be unprofitable through 2019. But operating losses from digital are expected to be their worst this fiscal year for Walmart (the company’s fiscal 2016 ends in January 2016). The image below graphically emphasizes this:
Source: Walmart 22nd Annual Meeting, Neil Ashe Presentation
Walmart is taking on unprofitable operations (for now) to grow the business into the future. The company’s goal is to provide a seamless shopping experience from online to in store.
Future total returns
The company is expecting revenue growth of between $45 billion and $60 billion over the next three years; revenue growth of between 3% and 4% a year.
In addition, Walmart plans to repurchase $20 billion in shares over the next two years. This is about 10% of the company’s market cap at current price. Share repurchases should normalize at around 2% to 3% of shares outstanding a year over the long run.
Additionally, Walmart currently has a 3.3% dividend yield. The company’s revenue growth, share repurchases and dividend combine to give investors expected total returns of about 8% to 10% a year over the long run.
The company’s margins are expected to fall this year and next year. After that, margins should improve as digital sales reach better economies of scale. This could well add to long-term expected total returns.
Walmart is also deeply undervalued at current prices. The company is trading for a price-to-earnings ratio of just 12.6 at current prices. Investors who initiate or add to a position now will likely see additional gains as the company’s valuation multiple rises over the next several years.
Final thoughts
Walmart is transitioning to grow its business. Investors who have been following the stock know this. The large recent sell off presents an excellent opportunity for long-term investors to initiate or add to a position in Walmart – the largest and most dominant retailer in the world.
Walmart has historically been very recession resistant. The company’s enormous size gives it a durable scale-based competitive advantage. Additionally, the company is shareholder friendly. The stock also has low volatility (excluding the recent steep decline). Finally, Walmart has solid long-term total return expectations. The company is a buy and ranks highly using The 8 Rules of Dividend Investing.
All businesses go through trouble at some point or another. Walmart’s announcement of lower earnings next fiscal year does not in any way mean the business is failing. Over the long run, Walmart will likely generate solid risk-adjusted returns. The recent price decline makes now an even better time to go long Walmart.
