Wal-Mart Faces A Growth Question As It Continues To Undergo Internal Changes

| About: Wal-Mart Stores, (WMT)

Summary

The continued weak consumer sentiment in the US, the onslaught of competition from e-tailers and higher costs related to wages are forcing big-box retailers to look inward.

Wal-Mart is making investments to strengthen relationships with its associates and enhance its digital infrastructure, which will potentially be accretive in the long term.

While the return generation may not happen in the immediate term, the underlying fundamentals are expected to be long-term strengths.

The continued weak consumer sentiment in the US, the onslaught of competition from e-tailers and higher costs related to wages are forcing big-box retailers to look inward and focus on improving store efficiency and customer experience. Retailers are increasingly concentrating on the issues of store closures and efforts to penetrate the e-commerce market.

On January 15, 2016, Wal-Mart Stores, Inc (NYSE:WMT) announced the closure of 269 stores worldwide-a record number. While there have been double-digit store closures in the last two fiscal periods, they were mainly in specific international markets (China, Brazil and Japan); the retail behemoth's standing in the domestic market seemed sturdy. In a single day, the company announced closures of 154 stores in the US (supercenters, discount stores, neighborhood markets and all of the 102 Wal-mart Express stores).

While the store closures had an impact on FY16 results, the company's decline of over 11% in operating income for the year is also driven by sustained pressure on same-store sales [SSS], increased wage expenses, continued deployment of funds in digital retail, and information technology. Even after adjusting for the US$0.9 billion charge related to January 2016 store closures, the company's operating income is about 8% lower than the previous year.

Wal-Mart is making investments to strengthen relationships with its associates and enhance its digital infrastructure, which will potentially be accretive in the long term. However, in the near term, the impact on profitability is likely to be significant. The impact of wage increases and other employee-related investments alone could be as much as US$1.5 billion in FY17, representing about 6% of its FY 16 operating income.

The last quarter of FY16 also saw a sharp, negative swing in the revenue growth trends. The year's unusually warm winters affected most retailers' performances in this quarter. But Wal-mart US' SSS growth of 0.6% in the last quarter of FY16 is considerably lower than the 1.5% achieved in the same quarter of the previous year and in the quarter ending in October 2015. While peers like Target Corporation have also seen lower SSS in the January 2016 quarter, Target's growth at 1.9% year-on-year is significantly higher than the levels achieved by Wal-mart stores.

Growth in the e-commerce segment has also tapered off in FY16. The segment growth in the January 2016 quarter was about 8%, and was less than 50% of the growth achieved in the quarter ending April 2015. E-commerce contributed about 25 basis points to the company's comparable performance in the year. The growth rate of gross merchandise value (GMV) sold on the company's global e-commerce platforms also fell in FY16. This is not entirely in tandem with the extent of investments into the e-commerce segment. Following investments of about US$1.2-1.5 billion earmarked for e-commerce websites and mobile commerce applications in FY15, the company planned about US$1.1 billion to be invested under the same head in FY17. The off take on the e-commerce platforms will potentially improve with the company's new initiatives, but the turnaround time for achieving considerable growth from the segment will be a critical factor.

With about 74% of consolidated revenue, the US is the single most important geographic market for the company. Its operating profitability in the US is sliding and the management guidance indicates that performance in FY17 will remain flattish. This raises the question regarding when the benefits of the currently underway investments will accrue. This is particularly significant from an investor perspective; consistent increase in dividend pay-out has been a characteristic of the stock. Further, with median yields of about 2.1% over the last 10 years1, the stock has been among the leading dividend payers in the US, driving its popularity among income-focused investors.

The dividend of US$2.00 per share for FY17 is a meagre 2% higher against the pay-out of US$1.96 in FY16, but it represents the 43rd consecutive year of increased dividends paid by Wal-mart. More critically, in the five-year period ending January 2016, the company's dividend per share increased at a CAGR of 8%; its total revenue grew at 2% CAGR in the period, and operating income declined compared to FY12. Seen in conjunction with this trend-and the company's history and focus on generating returns to shareholders in the form of dividends and even share buybacks-it is unlikely that future dividends will be lower than level announced for FY17.

However, considering the current environment in which the company is facing headwinds in the form of cost escalations, foreign exchange and intense competition, maintenance of sales growth will be a key determinant for the extent of dividends paid out. The anticipated margin pressure renders it critical that the company's sales growth recovers. If one were to assume that Wal-mart culled out nearly all its non-performing stores in January 2016, SSS performance in the quarter ending April 16 will be a number to watch.

The near-term pressure on the company's sales growth and profitability will likely translate into lower earnings for shareholders. However, the company's capital structure continues to remain comfortable, with a gearing of less than 1 time and very strong coverage metrics. Its long-term drivers remain robust, in the form of extensive geographic coverage, scale and strong financial flexibility. The company's balance sheet strength will be the critical factor supporting the various new initiatives and investments currently underway. While the return generation may not happen in the immediate term, the underlying fundamentals are expected to be long-term strengths.

The attractiveness of the stock on a short-term basis may be muted. For investors with shorter holding periods, the earnings in the form of dividends will also likely be flattish, limiting the returns. However, from a long-term perspective, the pressure on earnings will ease considerably once the company hits traction on its current initiatives, and its market position as the leading big-box retailer will continue to remain a major strength. The company will likely be a solid income generator for investors over the horizon.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.