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Summary

  • The international, neighborhood markets format, and e-commerce strategies are all doing well.
  • The food, pharmacy, and wholesaler strategies are destroying value.
  • Wal-Mart cannot expand both same-store sales and margins.

The retail sector has had a tough year, and Wal-Mart (NYSE:WMT) is no exception. The tepid U.S. consumer has wreaked havoc on most retail stocks. Wal-Mart, of course, blamed weather for weakness in Q1 revenue and earnings (three-cent hit to EPS). Sam's Club weakness was a result of an increase in price of the membership fee and stiff Costco (NASDAQ:COST) competition. Strength in international markets was a positive in Q1.

Wal-Mart's e-commerce initiative is also doing well, but this business is far below where it ought to be. Walgreen (WAG) confirmed sluggish staples sales with front-end comps up only 1.1%. The Walmart-2-Walmart money transfer business is a new opportunity to help grow margins (40% gross margin), but this is too small of a business to make a real difference to Wal-Mart's bottom line. The neighborhood markets format performed well with comp store sales up 5%.

Wal-Mart is struggling to increase same-store sales with guidance of flat comp store sales. In order to address the lack of comp store sales growth, Wal-Mart is expanding internationally, pushing its e-commerce strategy, rolling out the neighborhood markets format, and adding new product categories such as food and pharmacy. The key question for the stock is: Will these strategies be successful in growing overall comp store sales and expanding margins?

The international strategy is the right one, because there is no margin pressure as long as it is executed properly. Growing internationally can grow comp store sales and margins, so this strategy is positive on both counts. The neighborhood markets strategy is delivering 5% comp store growth with higher margins, so this is absolutely a good initiative as well. The e-commerce initiative might also be accretive to margins, if executed properly. In addition, this strategy is necessary for long-term survival in my opinion. So, e-commerce is the right strategy.

Here is where things get a bit questionable. Wal-Mart has entered the food and pharmacy businesses to help sales, but these businesses operate at lower margins than Wal-Mart's existing business. I would rather see Wal-Mart scale down the size of the stores and accelerate the move to neighborhood markets than see them entering these businesses where competition is brutal. So Wal-Mart's continued expansion in the superstore category with these new products is a mistake in my mind.

The wholesale business is another problem. Wal-Mart is not expanding this business, but it should consider spinning it off. This is a lower-margin business. Sam's Club raised the membership fee this year to offset margin pressure, but this move does nothing to address the stiff competition from Costco, which is eating its lunch.

Gross Margin

Net Margin

EV/EBITDA

forward P/E

Wal-Mart

24.8%

4.9%

8x

14x

Kroger (NYSE:KR)

20.7%

2.3%

8x

14x

Costco

12.6%

2.8%

16x

23x

Dollar General (NYSE:DG)

30.9%

9.2%

12x

15x

Amazon (NASDAQ:AMZN)

28.3%

0.6%

high

high

As you can see from the table I created above, the strategy to move toward the Dollar General model is a positive for margins, as is e-commerce. The food store, pharmacy and wholesaler businesses are pressuring margins. Yes, Wal-Mart's stock looks cheap. Its valuation has fallen to one of a food store because Wal-Mart is moving toward a food store business. Management strategies of adding food and pharmacy and maintaining the wholesaler business are destroying value, in my opinion. I rate this stock a sell.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Source: Wal-Mart Is More Like A Food Store - Not Only In Store, But Also In Valuation