The Future of Wal-Mart: Here's What to Expect

It's no accident that Wal-Mart Stores, Inc. (WMT) became the largest retailer in the world. It has over 5,000 retail stores serving more than 260 million people across the globe every week.

I believe the following six important strategies will transform the business over time.

1) Improving retail basics

Price is definitely a powerful driver for consumers, but consumers from across the income spectrum expect clean and organized stores which stock their desired goods and can complete their shopping swiftly.
If a retailer can deliver on all these requirements, consumers will feel good about their shopping and will return to that store frequently. Successful turnaround stories in retail, be it Dollar General Corp. (DG), Home Depot Inc (HD), or Family Dollar Stores, Inc. (FDO) have all been providing consumers with compelling and well-stocked merchandise in well-organized and clean stores.

WMT’s initiative on its Clean, Fast, and Friendly scores is a strong step in the right direction.
The Future of Wal-Mart: Here
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It is of greater significance considering the intense competition WMT faces. Management has rightly noted that even though it is not known how to grow a $500 billion per year business, they definitely know how to grow sales at a single store.

These strong retail basics will certainly go a long way towards realizing that goal.

2) Continued investment in digital capabilities

WMT is attempting to become the largest omni-channel retailer in the US.

The company runs its e-commerce operations business from California and not from Bentonville, Arkansas. California is closer to Silicon Valley’s technology and this demonstrates the company’s views on the importance of e-commerce channel to WMT.

I believe there is definitely a trade-off as the profitability levels are lower. However the company’s extensive investments in this channel and its willingness to incur over $1 billion in operating loss emphasize the long term importance of e-commerce channel for WMT in the long run.

WMT’s online grocery offering continues to get high marks from customers. As it expands, WMT can take advantage of its vast physical footprint and become a market share leader in this growing category.

3) WMT is improving its private brand mix

WMT has mixed success in its plans to push more private brands and exclusive relationships. For example, it had to phase out its Price first value brand and oats organic line.

Despite this I believe private brand is an area where the company could be more aggressive and thoughtful.

Success in private labels would not only help WMT in its competitive positioning against deep discounters (in particular on opening price points in grocery), but also help to subsidize margins. Margins in private labels tend to be several hundred bps higher as compared to nationally branded products. I also believe that efforts in theses segment along with exclusive tie-ups will help sustain demand for its brand and stores.

A case in point is Target Corporation (TGT), where its exclusive tie-ups with fashion designers Missoni and Lilly Pulitzer have led to considerable success.

WMT concentrates most of its private label efforts in opening price points, but it does not have to be so. A good example would be Home Depot which was able to create several $1 billion brands like Hampton Bay in ceiling fans and patio furniture as the competition is less intense from other national vendors.

WMT’s increased focus on private brands, which is intended to defend against the hard discounters growing their store bases in the US. It is clear from company’s recent investment in its Innovation Center that there is a stepped up focus on improving the quality and quantity of private label SKUs.

4) Simplified portfolio

Management has shown inclination to re-assess its portfolio as seen by the closure of several hundred stores.

I believe WMT needs to further simplify its portfolio. In simple words, it is extremely difficult to be everything for everyone; the larger and more diverse the business, the harder it is to manage.

I believe there is still immense scope to further simplify the company’s business. Investors would react positively to company’s more transformative approach like an asset sale or even something less drastic like additional store closures and reduced openings, as simplifying the portfolio could improve financial returns and free up additional cash to be distributed to shareholders

5) Cultural shift

One of the hardest things to do is to change a company’s culture.

A good example is when Home Depot decided to re-align and go back to its roots of being a customer service oriented company. It was not enough to just tell the store managers and staff to focus more on customer service to induce real change. Home Depot had to block access to online forms that had to be filled during parts of the day and went as far as cutting off e-mail to store managers. Otherwise this was essentially a waste of time for a store manager hanging out behind closed doors instead of being in aisle helping customers.

This is an over simplification of the changes that occurred in Home Depot, but it signifies that the company had to think “out of the box” to initiate the changes it desired. Presence of store managers in the aisles helping the customers motivated the front line sales associates in doing the same and the phenomenon became contagious and spread around the store.

WMT is making some progress, but a lot more to do. The company has already spent $2.7 billion over last two years as it increased wages to $10 per hour and added department staff. It is difficult to suggest what the company can do to drive behavioral changes, but the management needs to think creatively to alter its culture as was the case with Home Depot.

6) Lower profitability due to high competition

Lower profitability is a necessary evil in the renewal process for WMT and its shareholders. The company has already reset its earnings downwards by 15-20% from 2014 levels. This I suspect might not be a onetime reset considering today’s fast-changing retail world.

Best Buy Co Inc (BBY) had to go through a similar experience when it reduced its prices and had to accept lower gross margins when it tried re-gain market share against Amazon.com, Inc. (AMZN) and others. Kroger Co (KR) and other legacy grocery competitors have also been forced to consolidate and lower gross margins by over 200 bps to stay competitive.

Not drawing a line on the profitability might frustrate investors, but on the flip side it would endanger WMT’s business model. It might lead to WMT being less price competitive, loose the customer service battle and also not sufficiently invest in building digital capabilities.

No much upside at current levels

WMT shares have only had minor correlations to the market over the last 15 years. WMT’s size (it’s 1.4% of the index) dictates that WMT shares have had at least some modest correlation with the S&P 500 over the last 15 years (correlation of ~0.75), but it’s clear that the link was much tighter in the late 1990s than it has been since.

My 12-month price target of $75.05 are based on 16.5x 2016 EPS estimate of $4.55 (mid-point company guidance). This is above the 3-yr average of 14.5x, but the company is coming off a period of heavy investment spending and EPS revisions are starting to move up.

What should investors do now?

I advise investors to wait for stock to come down at least 5% and enter with long-term perspective.
Published on Oct 4, 2016
By kiran

Copyrighted 2016. Content published with author's permission.

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