Margins under pressure
Walmart’s (WMT) operating margins have been under pressure since 2011. Where it used to be 6.0%, margins have fallen to just 4.1% by FY18. More importantly, the pace of decline seems to have accelerated in the last few quarters. Starting from 2017, operating margins dipped below 5%, and this dropped further to just 3.9% in 3Q18, and 3.3% in 4Q18.
CFO Brett Biggs said during the 4Q18 results that "approximately two-thirds of the decline was driven by price investments in certain markets and the mix effect from our growing e-Commerce business. The remaining one-third was driven by Sam’s Club inventory markdowns associated with closures, and other international items, including the wind-down of our Brazil first-party eCommerce business."
Pace of margins decline is accelerating
Source: Company Financials
Structural headwinds
Management added that in fiscal 2019, Walmart will continue to make investments that will pressure the rate of margin decline, albeit at a more moderate pace.
A number of the headwinds seems to be structural in nature, including :-
- Increasing U.S. starting hourly wage rate to $11.
- Expanding paid parental leave for all associates starting from March 2018
- Launching free two-day shipping for customers.
- Enhancing value of Sam Club's Plus membership to include free shipping.
- Investing more to promote Walmart.com on a national basis.
- Removing tobacco sales from certain locations.
- Absorbing higher transportation expenses.
- Mix-effects from growing the eCommerce business.
Margin pressure happening across all business segments
Source: Company Financials
Could margins recover?
While management is doing the right things to develop the online business, and improve the welfare of its workers, it is not clear when, or if, margins will recover. Amazon (AMZN) has a different cost structure than Walmart. As its margins are nowhere as high as Walmart, it can afford to play an offensive strategy.
China could turn out to be another headwind. In the past, Walmart's suppliers could accede to its demand to cost-down by relocating their production to China. However, wages in China are no longer falling and the extent of outsourcing is already fairly extensive. In addition, Trump’s attempts to bring production back to the U.S. could derail Walmart’s strategy of “Everyday Low Prices.”
Is consensus too optimistic?
As seen below, consensus has imputed an operating margin of 4.36% for FY19, which is quite punchy compared to the 3.3-3.9% that Walmart achieved in 2H18. Consensus further assumed that margins will rise to 4.39% in FY20 and 4.51% in FY21. Depending on how aggressive Walmart pushes its online strategy, margins may continue to stay low for a longer period.
Consensus has imputed optimistic margins for FY19-21
Source: 4-traders.com
Is Walmart cheap enough?
As we highlighted in an earlier article - Walmart - Is It Cheap Enough Yet?, despite pulling back from $110 to $87, the stock still trades at 17-18 times P/E. This is at the high-end of its historical range of 13 to 18 times, which may not be supported if margins continue to disappoint.
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.
