Stocks and Shares

Hitting a brick Wal-Mart

Pile ‘em high, flog ‘em cheap, be tight on costs. That simple strategy has worked exceptionally well for Walmart since it was founded in 1962 by Sam Walton. Until now. Yesterday the company issued a profit warning and the stock plunged 10%, wiping out US$24 billion of market value at a stroke. It’s a reminder that big and “safe” companies aren’t always good investments.

Wal-Mart Stores Inc (NYSE:WMT) is massive. In its last full financial year it had sales of US$482 billion. Even after the stock plunged its market capitalisation – whole company value at current stock price – is US$212 billion. It employs over 2 million people in 11,000 stores spread across 28 countries. A lot of people rely on it for their daily bread, and a lot of things they don’t need as well.

So you’d be forgiven for thinking it would be a good place to invest. And you’d be in good company. Warren Buffett, the famous multi-billionaire investor, has been accumulating a big position since 2005, which has now reached about 2% of the company.

But you’d be wrong, just as Buffett has been at least partly wrong (many of his later stock purchases were well above today’s level). Which just goes to show that even the best investors make mistakes.

Walmart stock price, year to date 2015

WalmartStock

Walmart stock closed at $60.03 on Wednesday. That in itself doesn’t mean much. Until you realise that the last time it was at that level was on 9th December, 1999.

In other words, investors that owned Walmart stock in late 1999 haven’t seen a capital gain in nearly 16 years. Wow. Patience is a virtue. It’s certainly a good thing when it comes to investing. But that would test the reserves of even the most virtuous.

What’s more, that poor performance is despite massive stock buybacks in recent years that should have driven the price up. (When a company does buybacks it means company value is spread across fewer remaining shares, which in turn means the price goes up – all other things being equal.)

Walmart is proud that it has increased its dividend every year for the past 42 years. But I calculate that investors made only 1.5% a year from dividends over those 16 years.

Of course there have been dividends as well. And Walmart is proud that it has increased its dividend every year for the past 42 years. But I calculate that investors made only 1.5% a year from dividends over those 16 years. And that’s before paying income tax.

They may as well have held dollar cash or treasury bills. Such low returns don’t make up for the uncertainty of owning company stock, however supposedly safe it is. You also need to make a profit.

The Walton family – the founder’s descendents – still own just over half of the company, on top of whatever else they’ve accumulated over the years with their dividends. That’s worth well over US$100 billion. The company is undoubtedly a great success story. The kind of thing from which American dreams are made.

But things have been tough in recent years. The world of retail is changing. More and more people are eschewing the chance to drive through traffic to an out of town building the size of an aircraft hangar. Once there they get to spend many hours filling their cars to brimming point with various goods (and packaging).

Instead , these days many people prefer to make targeted purchases online and await delivery. They save time that way, and possibly even money (lower prices of goods, fuel). Walmart has been struggling to adapt.

In fact net profit in the year to 1st January 2015 (for some reason this is the company’s chosen reporting calendar) was the same as in the year to January 2011, four years earlier.

No growth for years. Nothing. Nada. Squat. Zip. Hardly the stuff of investment dreams. Profit growth is the main driver of capital gains.

This poor result is despite efforts to expand around the world, outside of the US home market. In fact in a previous job I inherited a list of recommendations for subscribers to an investment letter. Walmart was one of them. I soon recommended that people sold the shares.

Why? Because the US retail sector looked weak and Walmart was struggling to grow. Even worse than that it had just overpaid massively to buy a business in South Africa for several billion dollars.

When you see the management teams of giant, cash rich companies wasting money on overpriced acquisitions around the world – in their desperation to find growth – you know that all is not well.

When you see the management teams of giant, cash rich companies wasting money on overpriced acquisitions around the world – in their desperation to find growth – you know that all is not well.

Trust me: I’ve seen it happen from when I worked inside a big bank. Cash is wasted and value is destroyed, often in huge amounts.

Despite the overseas expansion the US still accounts for almost three quarters of Walmart’s sales. Of the remainder, around 8% of total sales comes from Walmart’s ownership of ASDA, a British supermarket chain.

US sales have been stagnant for years. Like-for-like sales, which exclude expansion from new stores, shrank 0.5% in the year to 31st January 2014 and rose just a tad, 0.5%, in the following year.

And UK supermarkets have been slugging it out with privately owned German discounters Lidl and Aldi in recent years. Prices have been slashed as the whole sector fights it out for market share.

What’s great for shoppers has been terrible for company profits. Walmart’s ASDA, with over 16% market share, has almost certainly been caught in the crossfire. Other markets around the world may have similar problems.

Incidentally, Warren Buffett also got caught out in the UK supermarket wars. He had a big investment in Tesco plc (LON:TSCO), the market leader which is still clinging to 29% market share. But that share has been falling too (there was also an accounting fraud to goose up reported sales).

Long story short, Walmart’s growth ran into a brick wall years ago. The management response has been to keep building more of the huge, out of town stores for which is it best known. Or to buy companies that already have them. Last year, total retail space grew 3%. But sales were up just 1.9%.

In other words, Walmart has been trying to walk up a down escalator. But why is this? A large part of the answer is that more and more people have been switching to buying stuff over the internet.

So it’s odd, to say the least, that Walmart’s main response has been to build more physical stores for customers not to use in future. But management seems to be waking up, finally. The rate of store openings will be cut, and the internet strategy will be emphasized more.

To be honest I’m not too optimistic about their prospects, if their corporate investor relations website is anything to go by. It’s one of the worst ones I’ve looked at for years, especially for such a big and important company. Hopefully the company’s online retail managers have a better idea of what they’re doing than the bureaucrats at head office.

And so to the profit warning and management guidance. Earnings-per-share (EPS) are expected to fall 3% to 9% this year when compared with last year. Then they’ll fall another 6% to 12% next year. Then we’re promised that they grow a bit the year after that, and finally settle into a 5-10% growth range three years from now.

Guidance is for flat sales this year (again), rising costs driven largely by wage rises (running into next year as well), and hence the falling profit forecast.

Ouch. It’s no surprise that the stock plummeted. Guidance is for flat sales this year (again), rising costs driven largely by wage rises (running into next year as well), and hence the falling profit forecast.

By the way, part of the excuse trotted out to investors is weak foreign currencies hitting US dollar profits. But currencies go up and down, and profit growth has been non-existent for years. Currency issues are a poor excuse for structural weakness.

And one final thing. For four of the past five years the company has paid out more cash to shareholders – in the form of dividends and share buybacks – than it’s generated in free cash flow.

Free cash flow is operating cash flow (cash profits) less capital expenditure (money invested to maintain assets or buy new ones). In other words, there’s a cash shortfall which has to be made up with new debt. Not usually a good sign.

The Walmart saga is another reminder that big doesn’t necessarily mean safe, following on from the – admittedly more serious – emissions rigging scandal at Volkswagen (see here for more).

Walmart is a low growth leviathan and likely to stay that way. It’s imprisoned by the physical bricks walls of its huge stores in a retail land increasingly made of electrical clicks. This is an important reminder that past success is no guarantee of future prizes. Things can change.

The stock deserves its low P/E ratio of 12.6, and probably less than that, as a reflection of its low to no growth outlook. For years the company bragged about “always low prices” for its products. I suspect that will continue to be the case for the stock price as well.

Despite the sharp price fall, this isn’t an opportunity to scoop up an investment bargain.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

Previous ArticleNext Article
Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.