Recent first quarter results released by Walmart (WMT, Financial) showed that the company is experiencing a period of major change. Total revenue was $122.7 billion, which is a 4.4% increase versus the first quarter of the prior fiscal year. However, excluding the favorable impact of exchange rate changes, revenue was 2.7% higher than the comparable period.
Comparable sales at U.S. Walmart stores moved 2.1% higher, with customer traffic gaining 0.8%. Comparable sales at Sam’s Club stores were up 3.8%, while customer traffic gained 5.6%. Internationally, revenue increased by 4.5% on a constant currency basis.
But profitability in the first quarter declined sharply, with earnings per share down 28% at 72 cents. Profit margins came under pressure due to competitive pricing, as well as higher shipping costs.
Growth potential
The company’s mixed results have meant that investor sentiment has been relatively subdued since they were released. The Walmart stock price has been relatively flat since mid-May, while the S&P 500 index has posted modest gains of 2%. Meanwhile, in the last five years, the retailer has underperformed the wider index by around 50%.
Looking ahead, Walmart could generate improving levels of profitability and a higher stock price. The company is focused on increasing its exposure to online sales and is enjoying success in doing so. After a slowdown in e-commerce growth in the fourth quarter of the previous fiscal year, online sales growth was 33% in the first quarter of the current year. The company expects it to be up 40% for the full year, and its decision to move into home delivery could prove to be a significant growth catalyst.
Walmart already has a pickup option for online grocery orders at over 1,000 retail locations across the U.S. It plans to increase that number to 2,000 by the end of the year, while also adding delivery as an option to 800 stores by 2019. This will mean that 40% of the U.S. population will be able to receive Walmart deliveries within a matter of months. This could provide a boost to the company’s growth rate, since online shoppers have basket sizes that are significantly higher than shoppers who only visit their physical stores.
The company is also expanding its online presence abroad. It has targeted the Indian economy through its acquisition of e-commerce specialist Flipkart for around $16 billion in return for a 77% stake. With online retail sales in India expected to reach $200 billion within eight years, this could provide the company with a further online growth avenue in the long run.
Changing business model
Rationalization of its asset base could also create a simpler business model that is more focused on its e-commerce growth potential. The decision to merge Asda with Sainsbury’s in the U.K. has netted Walmart $4 billion in return for a 42% stake in what could be a dominant retailer.
Synergies from the deal plus a lower cost base than many of its rivals could lead to improved sales growth in a highly competitive market. And with the sale of 80% of its Brazilian business yielding up to $250 million depending on performance, the company will be able to focus on its core operations to a greater extent.
Further, the company’s decision to focus increasingly on innovation could lead to stronger financial performance. Developments such as its personal shopper service, Jetblack, could allow the company to access younger and more affluent customers. It is essentially a virtual personal shopper that can shop for any request made via text. Similarly, the decision to open a smaller, convenience-focused Sam’s Club operation in Dallas highlights the company’s willingness to adapt to changing consumer trends. This could boost sales growth and lead to a smoother shopping process for customers that is focused on an increasingly digital experience.
Risks
One challenge facing Walmart is the cost of transforming its business. As mentioned, profitability in the first quarter declined, with additional e-commerce transportation expenses contributing to its fall. Investment in its online sales infrastructure also hurt the company’s bottom line, while there have been question marks surrounding the price paid for expansion in India. The price paid for Flipkart values the company at over $20 billion for a business that saw revenue growth slow to 29% in 2017 and losses grow by 68% in the same year.
Walmart looks set to be in a strong position to quickly scale-up its operations in India, however, with Flipkart offering potential synergies with the company’s existing operations in the country. And while profitability may be hurt in the near term by the additional investment in e-commerce operations, in the long run it has the potential to rejuvenate growth across the business. On a global basis, the online grocery market is forecast to grow at a CAGR of 17% between 2017 and 2022. This could catalyse the company’s future earnings-per-share growth rate and stock price.
Verdict
While the stock price performance of Walmart has disappointed in recent years and its first quarter results were mixed, it seems to have a sound growth strategy. Its focus on e-commerce growth could allow it to capitalize on global consumer trends, while expansion into new territories could allow it to gain access to higher growth rates. A focus on its core operations and on innovation could also mean it delivers improving financial performance.
Although the cost of transformation may be high in the short run, improving sales and earnings per share growth could be ahead in the long run. As a result, there could be a value investment opportunity on offer following the stock’s underperformance of the S&P 500.
