Wal-Mart Stores: Fighting Back

Summary

• In a world spiraling towards e-commerce which is dominated by Amazon, Wal-Mart is fighting back by reinventing itself as a technology company with physical stores.
• Wal-Mart’s secret weapon is its Data Café: a state of the art, analytics hub which is the world's largest private cloud.
• Wal-Mart will enjoy PE expansion if it succeeds at this transformation.

Leverage 55 years of Experience and Assets

Wal-Mart Stores (NYSE:WMT) is the world’s largest retailer with $485 billion revenue in its fiscal year 2017, $14 billion profit after tax, and an operating cash flow of $31 billion. It has over 11, 600 stores in 28 countries. In U.S. alone, it has 4,700 stores which is located within a ten-mile vicinity of 90% of the U.S. population. Effectively, this is a very powerful and cost-effective delivery network as it expands its e-commerce platform.

For the past 55 years, when Sam Walton first founded this discount store in 1962 and disrupted the entire retail industry then, it has grown in financial strength by disciplined growth, capital allocation and delivering an EDLP (Every Day Low Pricing) policy for its customers. Over the past decade, as buying habits are dramatically remolded by online e-commerce, Wal-Mart has lost market share and its revenue growth declined. But it is not dead. On the contrary, it has quietly been amassing assets to fight this inevitable battle for customers’ dollars.

Goal: Transform into a technology company

Big Data and Data Café is at the heart of this transformation. Wal-Mart now can chew and spit 40 petabytes of data, and to give its management and associates “real time” solutions to complex business problems, which in the past, would have taken weeks to compile, compute and analyze. This ability has far reaching benefits: from increased sales, more efficient inventory control, supply chain management, merchandising, efficient delivery options, and climate control and the switching of lights in the stores.

Wal-Mart is using technology both online and offline to maximize the seamless experience for its customers. For example, customers can elect to pick up their online orders at a Wal-Mart location. Instead of having to go inside the store, customers can pick up their order at an automated pickup tower which looms 16 feet tall and holds 300 small to mid-size packages. As the customer walks towards the tower, its doors would automatically open. A screen scans the mobile receipt and the bar code, and disburses the packages. Viola!

The acquisition of jet.com and on boarding its CEO, Marc Lore to be the President and CEO of Wal-Mart e-commerce, is a stroke of genius by Wal-Mart. Marc Lore is a proven successful e-commerce entrepreneur. Lore and Doug McMillon, the CEO of Wal-Mart have a common vision and similar culture: to use technology to transform the old bureaucracy into a technological retailer, and with speed. Other recent acquisitions include Bonobos, Modcloth, Moosejaw, Shoebuy.com, mostly targeting higher income millennials. Parcel, a logistics start-up acquired on October 3, 2017 is to execute same day delivery service in New York City.

At the Investor Community meeting, I discovered that jet.com has a very powerful technological platform. It is akin to a real-time trading platform, where it can monitor and dynamically help customers buy their goods and products from a total cost point of view. For example, in the past, customers would usually select the lowest cost product. Now, the system will encourage and incentivize the customer to buy from the closest vendor with the shortest delivery route. This is a win-win for Wal-Mart and its customer. Both save on time and costs. Another major incentive is that customers enjoy free two day shipping once they reached a $35 minimum order, and unlike Amazon (AMZN), they do not a need a Prime membership to do so.

Wal-Mart is ramping its cloud strategy and building its own deep neural networks, named OneOps by investing in Nvidia’s (NVDA) GPU chips, the leader in machine learning. It intends to build OneOps to 1/10^th the size of AWS (Amazon Web Service). And to protect its competitive edge, Wal-Mart has asked its technical suppliers to move out of AWS if they want to continue to do business with Wal-Mart. Competition is intense, as evidenced by Target’s (TGT) decision to leave AWS after Amazon's announcement to buy Whole Foods.

Strategic investment and partnership with JD.com

China is a core market for Wal-Mart's expansion plans. It has invested over a 10% stake in JD.com to leverage JD’s local knowledge, distribution centers, courier network and customer base. They will jointly develop a supply chain and inventory management system where online orders will be fulfilled by the nearest distribution center. Effectively this partnership with JD, a premier name for quality and authentic products, will help Wal-Mart penetrate the Chinese market with less risk and capital.

Mobile App

Wal-Mart has rolled out a comprehensive mobile app experience for the customer. It is called Mobile Express and thus far, there are three elements to this App.

Mobile Express Money Services enables money transfers to 200 countries. It cost less than using conventional banks and Western Union and draws additional foot traffic to the stores.

Mobile Express Pharmacy will enable the customers to refill their prescriptions and pick it up at an express lane.

Mobile Express Returns is a 30 second process where the customers initiate the return before arriving at a Wal-Mart store by scanning its QR code. Some items such as personal care need not be returned physically since it would be thrown away in any case, would receive an instant refund once the QR code has been scanned.

Amazon’s Move from Online to Offline

I was quite surprised and puzzled by Amazon’s purchase of Whole Foods for $13.7 billion. Yes, Whole Foods has 431 stores, but isn’t Amazon an online business model? Why did Amazon do it? Perhaps it was to counter Wal-Mart's 4700 points of distribution in the U.S. Perhaps Wal-Mart’s 10-mile proximity to 90% of the U.S. population is a powerful competitive edge. Why did Amazon cut the prices of Whole Food’s select group of products immediately the deal closed? Perhaps it was to combat Wal-Mart’s EDLP policy? Why is Amazon experimenting with “scan and go”, as are Wal-Mart and Sam’s club? And why is Amazon now considering the highly regulated pharmacy fulfillment business? Because Wal-Mart already has a pharmacy fulfillment business?

I think the answer to Amazon's actions may be found in the U.S. Census data. The estimated total retail sales for the twelve months ended June 30, 2017 was almost $5 trillion and e-commerce accounted only 8.5% of it. This data implies that both offline and online business models have a role to play for many years to come. It is clear that both Amazon and Wal-Mart are now stepping into each other’s business models to remain relevant in this highly competitive, low margin business where scale and volume are keys to profits.

Conclusion

What I do know from Wal-Mart’s Investor Day is that its management is relatively young, competitive, experienced, disciplined and shareholder aligned. This is not surprising as Walton Enterprises LLC still owns 47% of Wal-Mart. It is Wal-Mart’s business strategy to transform itself from the brick and mortar titan it is today, into a profitable technology/physical store hybrid so that it can continue to deliver billions of free cash flow and return it to its shareholders.

Wal-Mart intends to do by investing in technology, in expanding e commerce, penetrating deeper into new and existing customers’ wallet. To achieve this, they announced quite wisely, that they have to change its culture from within. They have let go of staff, hired new talents for the digital roles, increased wages of their associates, have started 20 training academies next to stores of excellence, which will increase to 200 by the end of 2017. They have committed to employ over 200k veterans to manage the stores. All this to promote a culture of excellence so that they can deliver a seamless and pleasurable shopping experience for the customers. All these activities prove that the company is alive and fighting back.

From an investment viewpoint, Wal-Mart trading at a 20 PE to 2018 earnings is a bit rich when compared to its long-term growth rate of 5.8%. Yet, when viewed in context of Amazon’s 140 PE, albeit it has a much higher growth rate of 40%, and that the stock market is at all-time highs, the valuation seems reasonable.

Furthermore, it has a 2.4% dividend yield, a $20 billion stock buyback over the next two years and its e-commerce business is expected to grow 40% from the current $11 billion top line. As it morphs into more of a technology company, its PE might expand to 25, which imply a stock price of $109 and a 27% return based on the current stock price of $85.80. However, prudence suggests patience and to wait for pullbacks to $77- 72 levels before initiating a position. After all, Wal-Mart is now basking in the afterglow of its terrific investor day.

Analyst’s Disclosure: I am/we are long WMT. 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.

Comments

[PRBURNIM]

Congratulations on a very well written and thoughtful article. They are an incredible competitor now with both training and technology to compliment their vast distribution presence and buying power. Thank you...

[Wiseyou]

@Sherli Looi

Thank you for an insightful analysis and a lot of very useful information about the management. Ultimately, the management and culture of a company is the most important determinant of its business model. By hiring a CEO of its digital Enterprise unit, Walmart transformed itself into a digital retail powerhouse.

I did not know that Walmart built the world’s largest data processing center and that they are now forcing all their suppliers to leave Amazon. With nearly half a trillion in sales from these suppliers, this must really be hurting Amazon’s AWS and at the same time boost Walmart’s digital enterprise revenues. It nor often one can make billions at the expense of your most vicious competitor,

I like Walmart’s innovative approach to delivery. First, the concept of providing free delivery if people order over $35 will persuade people to buy more. Second, the idea of an automated pickup system in the form of a tower in the parking lot is great. Third, the concept of providing interactive intelligent routing of deliveries for customers is brilliant.

The delivery system provide flexible and the lowest cost shipping solutions for the customers. If they live within 10 minute of a Walmart, which 90% of Americans do, many will want to just pick up without having to park. For the 10% that live further away, they can work with Walmart to figure out the best delivery route at the lowest cost. This is so much better than Amazon and Costco.

In my opinion, Walmart is Amazon’s and Costco’s real competitor. They have the size, the purchasing power, the commitment to lower prices, and the intelligence to go toe to toe with Amazon and take business away. By having nearly 5000 stores that is close to where 90% of Americans live, they have a much more efficient and flexible delivery system. They also have lower cost and therefore lower prices than Amazon.

I agree with your comments about Amazon’s purchase of Whole Food. Why did Jeff Bezos buy Whole Foods? With only 470 stores, WF does not give Amazon infrastructure they need for more efficient and lower-cost delivery of food. Amazon lowered prices on staple foods in Whole Food but I am skeptical that this would increase the revenues or earnings. Whole Foods also caters to customers who really don’t care about the price as much as they prize freshness, quality, and special foods.

With Walmart and Costco offering food at much lower cost, I don’t think that lowering prices at Whole Foods will attract customers that shop based on prices. Until they revamp their expensive delivery model, I suspect that Amazon cannot compete on price alone. Costco’s Instacart and GoGrovery cannot compete with Walmart’s powerful computer algorithms.

I recently went shopping at Walmart to see how the food section of their stores are now organized. I bought about 12 items and was pleased to find that the total amount that I paid was less than $20. I used a self-checkout counter and was out of the store in 15 minutes. In terms of convenience and pricing, Walmart cannot be beat.

Finally, I am glad the Walmart is investing in academies to train their store managers. The managers will be the future of the company. They are the ones that have interact with the neural network and be technologically empowered to manipulate and understand the massive data flowing through the system for their decisions.

[czero]

I added WMT shares in late 2015 to my dividend portfolio and I think that their business, at those discounted prices, will provide a solid return over the coming decades. They're like McDonalds, every now and then they get into a rut and need to reinvent and realign themselves with what their customers want. Looks like they pulled it off this time. However, this isn't a business that I consider to be a generational holding, because their competitive moat is not very big or very deep, and the general opinion of WalMart is still very poor due to store issues and their rather eclectic customer base.

[Hillbilly Stock Star]

I bought $WMT my bet is higher in 12-18 months! Long.

[ajny]

You nailed it.

[vmg]

Hey Wolfman 105, I knew someone was missing at WMT but I didn't realize it was you. To be truly relevant, as an investment, IMO a company should throw off some dividends & growth. I will admit AMZ has the growth thing down pat. But do you really believe they will continue that 40% growth rate, especially with the Wolf ( I meant WMT) knocking at the door. My wife started her position at $50.11. I got started a bit later. VMG - Long WMT,

[GoLongWithMe]

Long WMT. Glad I got in earlier this year at $69

[timcos]

I am a online Walmart shopper I noticed the improvement in delivery times several months ago. local store pickup and home delivery was disappointed years past but not anymore great improvement! I dipped my toe in and brought some shares last week at 79 very happy now.

[wolfman105]

poor walmart..attempting to be amazon. i dont shop walmart..because well it's walmart.

[LoydsofLondon]

i think the article's point is WM is a discount store focused on brick and mortar but expanding into e commerce at a rapid rate. Will its customers prefer its e commerce over Amazon? My guess is yes.

[sheepdip]

BUT Walmart has targeted 40 billion in share buy backs . That shows they have little interest in
pouring money into growing the company by expansion or inovation. Walmart is a discount store. It is a Sunday outing for many families in America , mom & pop can shop and the kids can
run around. Walmart doesn't need drones or UPS types to ship purchases , buyers show up in
their own vehicles. Walmart just needs to squeeze their suppliers a bit more.

[NYC1965]

I suggest that you look at how much of AMZN is actual e commerce, not as a filler for others or the cloud (AWS)which they do very well. Then look at how WMT is ramping up with JET.