Wal-Mart Stores (WMT) is the world's largest retailer with annual sales of almost $470 billion and a market value of ~$250 billion. The company operates through three segments - Wal-Mart U.S. segment, the Wal-Mart International segment and the Sam's Club segment. The US segment accounts for 60% of the sales while Wal-Mart International accounts for 26% of the overall revenue. Wal-Mart has shown tremendous growth over the last two decades to become the No.1 retailer in the world's biggest economy. However, growth has slowed down quite appreciably in the last couple of years as the company attains saturation in the US market. The company has been dogged by a number of problems in the last few months such as bribery scandals, breakdown in normal operations in some stores as well as increasing competition. The stock price has meanwhile been touching new all time highs, as investors look for safe havens in an uncertain world. I am bearish on the stock given its high valuation amidst slowing growth and increasing competition.
Why I would sell Wal-Mart
- Competition increasing from lower priced stores - Wal-Mart's business model is built on providing objects of daily use at the lowest prices. However, competition is increasing from other low cost retailers like Family Dollar Stores (FDO), Costco (COST) and Amazon (AMZN). These companies are running their stores at wafer thin profit margins and are taking market share away from WMT. If WMT cuts prices further, it will lead to lower margins and profits. If it does not, then it will cede more revenues to competitors. This is not a happy situation for WMT.
- Low Employee Morale - Wal-Mart has been under fire for a long time for badly treating its employees, giving them very low wages and few benefits. WMT has been cited as a prime example why income inequality is increasing in the US. While Sam Walton's heirs are all billionaires topping the rankings of the rich, the majority of WMT's hundreds of thousands of employees are barely managing to pay their bills.
- Slowing US growth - WMT derives most of its revenues from domestic operations in the US where it has a dense network of stores and logistic centers. However, US growth has almost flattened over the last couple of years eking out a yearly growth rate of just 1%. The company has failed to successfully replicate this model in other countries. It has struggled to expand even in other western economies which are similar to the US. The company has been trying hard to get favorable legislation passed in India to help drive its future growth. The company has come under criticism from the Indian lawmakers over its lobbying practices. In China too, WMT has faced problems in trying to expand.
- WMT's Customer Satisfaction going down the drain - Wal-Mart was placed last amongst the department and discount stores in the American Customer Satisfaction Index. This is the sixth year in a row that a company has either tied or taken the last spot. There are reports that customers are not being able to find daily use stuff in WMT stores, as there are not enough employees to stock the shelves. The reason is that WMT is decreasing headcount while the number of stores is increasing.
- Near Term Issues in the US - The company is facing problems in the US where the economic growth remains tepid at best. WMT hit the news when an email leaked about the company facing the weakest February in the last 7 years due to increase in payroll taxes. As US faces tough choices due to growing debt and fiscal problems, the economy will remain in the low growth mode.
- Competition is rising from unlikely places - Technology has changed the retail market dramatically giving rise to strong e-commerce players like eBay (EBAY) and Amazon. WMT has managed to fend off the e-commerce challenge quite successfully and is now a big e-commerce player itself. However, technology continues to throw up new players. Apple (AAPL) and Microsoft (MSFT) are rapidly opening their own stores and Google is becoming one of the fastest growing e-commerce companies using its search engine dominance to sell products online. E-Commerce continues to cut margins since people look to cut brick and store profits, by directly sourcing from manufacturers and selling to customers.
- Valuation is slightly on the higher side - WMT is not a cheap stock with a P/S of 0.5x and P/B of 3.3x which is at a slight premium over the industry average of 0.4x and 3.2x respectively. I don't think the premium is justified given the problems that the company faces in the future. The company is yielding a dividend yield of just 2.2% which does not make it too attractive for dividend investors.
- Corporate Governance Issues - WMT has been rocked by a series of corruption scandals at its foreign subsidiaries in Mexico and India. The size of the scandal indicates that it is a systematic problem rather than an isolated one. It seems that top US managers neglected bribery concerns which were repeatedly raised. A top manager in India was fired after irregularities surfaced over payment of bribes for getting permits. This has frozen WMT's expansion plans in India.
a) Logistics and Scale - WMT managed to dominate the retail market in US through an excellent nationwide network of distribution centers. The company has the widest logistics network in US, which allows it to cost effectively supply to thousands of stores. The company's supply chain management and IT systems remain second to none.
b) Remarkably Consistent Margins and Return ratios - What is remarkable about WMT's financial statements is the consistency in margins and return ratios. The company's operating margin has remained at ~6% over the last 10 years, while ROIC and ROE remained near the ~12% and ~20% levels. The company was almost unaffected by the Lehman crisis, which saw most blue chips take a big hit to their revenues and earnings.
WMT has shown a strong performance over the past 5 years returning ~44% compared to the ~19% return given by S&P 500. However brick and mortar retailers like Target (TGT) and Costco have performed as well, if not better than WMT. Top e-commerce players like Ebay and Amazon have performed much better giving returns of 84% and 275% in the same period. WMT currently trades near its all time high of $77.6, as the stock got a boost from the rally in the broader market over the last few months.
WMT is looked upon as a solid safe stock in an uncertain world and this is one of the main reasons why the stock has shot up in the last year. While a number of teething problems and scandals have rocked WMT, the stock has not shown any signs of responding to these concerns. Going forward, WMT faces increasing competition and market saturation. The company has become a victim of its own size and is not managing to grow in the US market which accounts for more than ~60% of its overall revenues. The company's valuation is not reflecting these issues and trades at a slight premium over the industry average. Apple which is somewhat like WMT in its size and market share dominance, has seen its valuation go down drastically in recent days as the market starts getting concerned about future growth. While technology and retail industry are very different, WMT's multiples could take a sudden dive if investors start worrying about WMT's growth. I would sell WMT near its all time high and look for other opportunities in the retail industry.