Wal-Mart: Great Stock, But Shipping Logistics Need Work

| About: Wal-Mart Stores, (WMT)

Summary

WMT has been one of my favorite investments to suggest since late 2015 and to hold since earlier in 2016.

The challenge for earnings in the next few quarters includes the impact of high shipping costs for online orders.

Wal-Mart is a powerhouse at squeezing costs and maximizing their operations, but the shipping system is not complete.

The impact of Wal-Mart picking up a little sales volume from Target in Q2 and Q3 may mask some of the challenges from shipping costs.

I expect earnings to pick up materially within 3 years and view WMT as a “buy”.

Wal-Mart (NYSE:WMT) has been one of my favorite stocks since it first hit around $60 last year. I began publishing several articles on the big retailer to remind investors that the company was not going anywhere. When a retail giant trades at around 12 times earnings (higher now), has multiple decades of consecutive dividend increases, and has huge economies of scale, it doesn't need to be "going anywhere". All Wal-Mart needed to do was to be able to continue doing what they were doing. The combination of dividends and share buybacks was a sufficient reward to shareholders. Since my dividends are set to reinvest, both dividends and share buybacks serve the same purpose. They both increase the ever so tiny percentage of the company that belongs to me.

I added Wal-Mart to my portfolio before their first quarter earnings were released. There was nothing unattractive about the investment. The ratios were great, the dividend history showed management knew what mattered to shareholders, and the new strategies (including higher pay) matched my views about the best way to run a retail giant.

Shipping

Wal-Mart has a great website. The two major points of this website are to allow customers to find a product and to order the product, and Wal-Mart has excelled on both of those metrics. However, there is one area where Wal-Mart still needs quite a bit of work: Shipping. This is ironic because Wal-Mart's claim to fame is their operational excellence. The company understands how to run a low cost leader. They did it so effectively they sent competitors into the bankruptcy system.

The Problem - Part 1

The big issue with shipping order's from Wal-Mart's website is that their systems don't organize shipments effectively yet. Buyers can save money by ordering more products at once. Offering buyers an incentive for larger orders is just common sense when the products will need to be shipped. The savings on shipping charges should be excellent, but they don't exist yet.

To test Wal-Mart's system, I sent my wife shopping on their website… Is there another option? She assured me that her shopping was the best test…

A Rabbit Trail

Even as a shareholder in Wal-Mart, I maintain an Amazon (NASDAQ:AMZN) Prime account and use it for a great deal of my shopping. I don't have an emotional attachment to shopping at Amazon, but I found prices were often attractive and the review system protected me from buying inferior products. As a shareholder in Wal-Mart, it is my hope that they will be able to establish a database of reviews as robust as the one on Amazon.

The Problem - Part 2

When the orders started coming in from Wal-Mart, they were shipping the order in multiple boxes. This is not entirely unusual, but somehow a small order turned into 3 separate shipments. As a customer, that didn't bother me at all. As a shareholder, the use of money bothered me. Don't get me wrong, if I was holding shipping companies like United Parcel Service (NYSE:UPS), I would be thrilled for the short term. The impact of Wal-Mart pushing for more online purchases could be excellent for the carriers in the short term. In the long term I foresee drones and the ability to combine orders leading to a decline in revenue for the shipping companies.

Financial Implications

Even as Wal-Mart works to grow their online presence and enhance their store, it appears that their operations for shipments are still pretty far from streamlined. This should make the margins on internet sales (after shipping costs) look much weaker than they would otherwise be. I expect these margins to improve materially over the next few years as Wal-Mart gets it sorted out.

To go a little deeper on the strategy, I should also emphasize that I agree with Wal-Mart's strategy. They need to establish a strong online presence and build the competency of handling those kinds of transactions. Waiting until they had their operations perfect before moving would have cost them too much market share.

In a nutshell, I agree with Wal-Mart's choice to push into the online space, but I also foresee some difficulty in their online margins over the next 1 to 3 years. Within 3 years (rough estimation) I would expect Wal-Mart to report significant gains on efficiency in their online sales and a reduction in their shipping costs as a percentage of online sales of physical merchandise. I'm intentionally excluding the impact of any sales of goods that can be delivered electronically (e-books, movies, and so on).

Conclusion

Wal-Mart remains a "buy" in my book. My holding period for shares is indefinite. I expect the margins on the online sales to struggle some from higher shipping costs. However, I also expect Wal-Mart to be picking up some sales volume from Target (NYSE:TGT) over the second and third quarter. The increase in volume could provide some leverage on the fixed costs and mask the impact of higher shipping costs when investors and analysts are glancing at the statements. My view on TGT is also bullish, and I own shares of TGT as well (purchased after the collapse).

I like Wal-Mart for the combination of a low P/E ratio, a strong dividend yield, and an expectation of earnings improving materially after a couple of years.

Rating: Buy WMT

Rating: Buy TGT

Disclosure: I am/we are long WMT, TGT.

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.

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