The year 2015 has been a rough one for Wal-Mart Stores, Inc. (NYSE:WMT) investors. Year to date the company’s stock price has fallen by nearly 30%. The company reported second quarter earnings on August 18th and they were below expectations. Its second quarter profit was $3.48 billion, down from $4.1 billion in the second quarter of 2014. In addition, the company lowered its 2015 fiscal year earnings projection from $4.70 to $5.05 per share to $4.40 to $4.70 per share. Investors were disappointed upon the release of these results, and by the end of the day the stock price fell 3% to $69.48. That is the lowest price that the stock has traded at in nearly 2½ years.
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In the latest filings, Berkshire Hathaway remained a large holder of WMT with 60.4 million shares worth about $4 billion. Insider Monkey, known for its research (read the details here) showing that tracking hedge funds’ long positions can be beneficial, shows that Masters Capital had calls on about 6.8 million shares of WMT, and Alyeska Investment Group had a new position of calls on 5.6 million shares. Pzena Investment Management and First Eagle were also holders of WMT shares, placing them among the top ten shareholders with respect to hedge funds. Berkshire’s enduring investment in WMT should give investors confidence in their long positions in WMT and shows that value is to be had by investing in the company.
The problems for Wal-Mart are many. The first is fierce competition. Discount stores such as Dollar Tree, Inc. (NASDAQ:DLTR), Dollar General Corp. (NYSE:DG), and Target Corporation (NYSE:TGT) are eating into Wal-Mart’s business. These companies are smaller, leaner, and more aggressive than Wal-Mart. This is evident to these companies’ investors as their stock prices are up 37%, 17%, and 24%, respectively, over the last year. Wal-Mart, which gets about 55% of its business through the sale of groceries, has also been hurt by discount grocery chains such as Kroger Co (NYSE:KR), a low-cost alternative to Wal-Mart. Investors have bought into Kroger’s concept and consequently its stock price is up by nearly 34% over the last year. In addition, Whole Foods Market, Inc. (NASDAQ:WFM) is planning on opening up a chain of lower priced stores to challenge both Wal-Mart and Kroger.
Future Headwinds for Wal-Mart Stores, Inc. (NYSE:WMT)
The second problem that Wal-Mart faces is cost control. While revenue was flat in the latest quarter, $120.2 billion versus $120.1 billion in 2014’s second quarter, operating expenses went from $23.4 billion last year to $24.1 billion. As a result, the company’s income from continuing operations was down by $454 million year-over year. Also, its operating margin has dropped to 5%, and there is very little chance that the company will be able to reduce costs anytime soon.
For instance, in February the company announced that it would increase the pay for all of its lower paid employees. Effective April 1st 500,000 Wal-Mart workers saw their pay raised to $9.00 per hour. In 2016, their pay will rise to $10.00 per hour. It is estimated that the pay raises will increase Wal-Mart’s payroll by about $1 billion per year.
In an attempt to deal with competitors like Jeff Bezos at Amazon.com, Inc. (NASDAQ:AMZN) and eBay Inc (NASDAQ:EBAY), Wal-Mart is expanding its E-commerce business. Wal-Mart’s CEO Doug McMillon thinks that E-commerce is the key to the future growth of the company. So in addition to the pay raises, the company will have to bear the huge expense of expanding its E-commerce business. It is estimated that the company will invest $1 billion in its E-commerce business this year and increase its investment to between $1.2 billion and $1.5 billion in 2016.
What is Ahead for Wal-Mart?
While sales and growth have been flat for Wal-Mart Stores, Inc. (NYSE:WMT), its management team is experimenting and shaking things up. That gives me hope for the future of the company and for the future of its stock price. I think that its investment in E-commerce will eventually pay dividends, financially and strategically. As a result of the company’s massive national footprint, it should be able to effectively deliver goods to almost every corner of the country. In 2015, it is predicted that the company will gross $13 billion in revenue from its E-commerce business, a healthy 30% increase from 2014.
Another experiment that is working for Wal-Mart is the introduction of small neighborhood stores as opposed to large supercenters. The small neighborhood stores attract grocery shoppers in a way that supercenters fail to. Same store comps were up 1.5% at supercenters but up 7.3% at the smaller neighborhood stores. The company announced that it would open up 270 to 300 small format stores during 2015, but eventually had to settle for only 235. In 2016, the company will open an additional 160 to 170 of the smaller format stores.
With the innovations that Wal-Mart is making, I would not write it off as an investment idea. The company has a PE of 13.3, which means that it trades at a discount to competitors such as Dollar Tree (22.2), Dollar General (21), and Kroger (19). Also, it is still solidly profitable, and it pays a dividend of $1.96 with a yield of 2.9%. I do not expect that Wal-Mart’s stock will move much higher in the near future, but for the long term investor – now might be the time to start buying shares of the stock on price dips.
Disclosure: The author of the article has no position in WMT or the other securities mentioned.
