Wal-Mart's Struggling Online Business Is A Big Concern

Summary

• Wal-Mart same store sales were up 1.5% in the latest quarter.
• The market reacted positively by chasing the stock up.
• But the online business was only up 10%.
• Wal-Mart's weakness in the online business is a big concern.

On the morning of November 17, Wal-Mart (NYSE:NYSE:WMT) reported results that impressed Wall Street. The stock moved from $57.87 the previous day to close at $59.92 by the end of the regular trading day, a spike of 3.54%. In the wake of the earnings release, several Seeking Alpha authors have turned bullish.

While the gain is impressive, this article will examine the reported numbers more carefully to unearth an important concern moving forward. But first, I will examine why the market rightly responded positively to the same store sales metric.

Same Store Sales Met Expectations

In my previous article published just days before the earnings release, I argued that same store sales growth (referred to as comp sales in the Wal-Mart world) is the single most important number for investors when judging the performance of a retailer. I also argued that Wal-Mart's Q3 growth of same store sales needs to be at least 1.5% in order to meet market expectation.

Coincidentally, the Q3 same store sales for Wal-Mart U.S. has grown by exactly 1.5%. More impressively, same store traffic has grown by 1.7%, but the average spending per customer has declined 0.2%. Small format stores turned in even stronger performances, reporting same store sales of 8%.

Market sentiment had been negative since the company declining EPS guidance at the October 14 investors meeting. When same store sales, which is the most important measure of retail store success, met expectation, the one-day 3.5% increase in stock price is completely understandable. However, there are a few numbers buried in the earnings release that do not bode well for Wal-Mart.

Wal-Mart's Online Business Slowing Down

Important information about the digital business is buried in page 6 of the earnings call transcript. In typical Wal-Mart fashion, when a strategic business unit of the company did not do well, CEO McMillon would switch the focus from the short term to the long term. His choice of words regarding the online business is worth reproducing here:

"Last month, we told you about our longer-term plans to grow ecommerce sales and GMV. That plan anticipates ebbs and flows along the way, but we are confident in our targets. We continue to expect to grow mid-to-high teens for this fiscal year. During the third quarter, Global eCommerce sales and GMV growth both came in at around 10 percent. This was due primarily to continued economic challenges in our major international markets, including Brazil, China and the UK. In the U.S. where we have seen good growth for the year, we continue to make progress on key initiatives, but we know we have more work to do."

The upshot here is that the digital business is growing only at a disappointing 10%, the lowest rate since the Walmart.com sales were broken out and reported separately 8 quarters ago. This is a far cry from the 23% growth rate reported by Amazon (NASDAQ:AMZN). Even Target's online business is growing at 20%, twice as fast as Wal-Mart online.

At the rate the digital business is slowing down, Wal-Mart would find it impossible to be a significant force in the online world. In order to have the scale to compete effectively with Amazon, Walmart.com needs to grow much more than 10% to have a prayer of catching up. Even the mid to high teens anticipated for fiscal 2016 would be far from sufficient to close the gap with Amazon, as a glance at this chart and some quick math would verify.

Importance of Online Retail

All this would be unimportant if the brick and mortar world was healthy and growing at the same pace or faster than online retail. However, this is not the case. The chart below shows that the online retail industry has been steadily taking away sales from the brick and mortar world in the last 15 years, regardless of whether the economy is strong or in recession.

The online retail business shows no sign of slowing down. It has been reported that the online retail business grew by 15.4% in 2014, exceeding $300 million for the first time. The online retail industry's consistent growth can be seen below:

Don't Bet Against The Oracle

The weak performance of the Wal-Mart online business, which grew only 10% in the latest quarter versus 23% for Amazon, could be the primary reason Warren Buffett has recently reduced his holding of Wal-Mart by 7%. When the Oracle of Omaha is selling, it does not seem wise to be buying.

To be sure, Buffett's sale took place before the Q3 earnings release. But even after November 17, several analysts remain skeptical of the turnaround story articulated by Wal-Mart management.

Conclusion

Wal-Mart is currently in a marketing war on two fronts. In the brick and mortar front, new evidence reported on November 17, specifically the Q3 same store sales growth of 1.5%, suggests that Wal-Mart is holding its own and perhaps even beginning to make progress against traditional rivals Kroger (NYSE:KR), Target (NYSE:TGT), and Costco (NASDAQ:COST).

The situation in the online retail front is exactly the opposite. The Wal-Mart online business has grown only 10% in the latest quarter, way behind the pace of 23% reported by Amazon. Because Amazon's online sales is already more than five times larger than Wal-Mart's online sales, a growth rate below Amazon implies that Wal-Mart is perhaps never going to catch up.

Gaining share in the slow-growing brick and mortar market but losing share in the fast-growing online market is an ominous sign for Wal-Mart. If current trends continue, Wal-Mart claim to be the world's largest retailer may not last long. Already, it is no longer the world's most valuable retailer.

Investors need to be cautious and not jump on the bullish bandwagon too quickly after the November 17 earnings release. The recent rise in WMT stock may just be a dead cat bounce rather than a true turnaround.

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.