One thing that investors can't say about Walmart (NYSE:WMT) is that there has been a clear lack of effort to transform the company. Amazon (NASDAQ:AMZN) came on the scene many years ago and disrupted the whole sector. Walmart, for a few quarters some years back, found itself standing still as Amazon raced ahead with its market share gains.
I distinctively remember the bearish coverage back then which insinuated that Walmart's dominance in retail was over. While this may be true to a small degree, I think few expected how the company has tried to reinvent itself, especially in the digital channels. In fact, many would agree that Walmart's response to Amazon's threat has been far bolder than that of many of its retail counterparts such as Target (NYSE:TGT) and Kroger (NYSE:KR), and I think the company should be applauded for this.
Fast forward a few years later, which have included a host of acquisitions (the $16 billion Flipkart deal being the latest), and the Walmart of today doesn't look anything like the company we saw a mere 5 years ago. We have been long this stock since mid-2017. Although we have seen quite a large piece of paper profit this year, the company's recent first-quarter results did nothing to change our long-term view. Here is our reasoning behind this.
First, sentiment in this stock has been pretty depressed since the turn of the year. Why? Both the fourth quarter of last year and Q1 of this year didn't go down well with investors despite the growth we witnessed in e-commerce, for example. Online sales grew by 23% on a rolling quarter basis in Q4 and 33% in Q1. This growth, though, is adversely affecting margins. Operating margins over a trailing 12-month average is now at 4.1%, which is a full 2% down from its peak in 2011.
What I would say to investors here is that it is going to take Walmart time to right the ship with respect to operations. The company has so many moving parts in that it is trying to tailor its offerings to different clientele all at one time. Just a short 3-5 years ago, WMT was solely known as the bargain-based value brand. However, now the retailer wants wealthier people buying its stuff, even if they don't want to set foot in its stores. When one includes the host of recent acquisitions, along with the running of the offline stores, it is easy to see why streamlining everything together is going to take time. I firmly believe that out of the present chaos, order will eventually come. Furthermore, operating margins, which definitely have been adversely affected by high shipping costs, will rise once Walmart becomes more efficient. I'm estimating around the 4.4-4.5% level next year.
Whereas Amazon may have the technical expertise where it can control inventory levels much better because of accurate reporting, Walmart's advantage is its scale and balance sheet, which it has leveraged over a while. Just look at what the company is doing in online grocery. The retailer soon will be in a position for an initiative that will be able to serve half the country's population with grocery delivery. Walmart really had no choice here but to go on the offensive as a result of Amazon's entry into this market through its Whole Foods purchase. Although groceries is still in its infancy in e-commerce, I can see this trend changing. Why? Well, with people working longer than ever, time is money. It's like anything else - once customers see that there is no problem with buying food online, we will see a big increase in volume here.
Grocery is where the ultimate battle will be won, and here is where Walmart can really leverage its scale. Logistics and inventories should be far less of a problem here, given the massive size grocery already makes up of the company's business. I just feel the cost advantage of Walmart in this division will eventually be seen by customers. The company has made it clear that operational income will be sacrificed temporarily to build the business. I expect Walmart to defend (which will mean aggressively promoting) its grocery division very strongly. Let the battle begin! Remaining long WMT.
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.
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