Updating My Thoughts on Walmart

GuruFocus.com
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- By The Science of Hitting

Walmart (WMT) reported results for the fourth quarter of fiscal 2019 on Tuesday morning. The company delivered another solid performance in the U.S., with comp store sales climbing 4.2% (including a 40 basis point benefit from the early release of SNAP benefits as a result of the government shutdown). For the year, U.S. comps increased 3.6%, the best number Walmart has reported in the U.S. in a decade. As shown below, the company's two-year stacked comps have steadily improved during CEO Doug McMillon's tenure. This is one of many examples of how the company has improved its business under his leadership.


The company continues to see strength in its U.S. e-commerce business, with revenues up 43% in the fourth quarter and 40% for the year. Over the past two years, Walmart's U.S. e-commerce revenues have nearly doubled to roughly $15 billion. If management hits their target for 35% growth in fiscal 2020, the U.S. e-commerce business will report more than $20 billion in revenues.

While domestic profitability continues to be under pressure from the e-commerce business and price investments, it's worth noting the U.S. stores leveraged operating expenses for the eighth consecutive quarter. The business is performing well, even if that's not always evident when you look at the consolidated bottom line (as noted at the company's Investor Day, it is targeting 20 basis points of annual expense leverage in the coming years).

For the year, adjusted earnings per share increased 11% to $4.91 per share (free cash flow declined by 5% as a result of the timing of vendor payments). However, that growth looks less impressive over a longer time horizon: Earnings per share in 2019 were roughly in line with 2014. Walmart has digested some sizable investments in the e-commerce business, as well as the costs associated with some recent deals (most notably the Flipkart acquisition). As I'll discuss in a moment, management's commentary leads me to believe that these sizable investments are unlikely to abate anytime soon.

Looking to 2020, guidance calls for "at least 3%" constant currency revenue growth, with U.S. comps up 2.5-3.0%. EPS is expected to decline low-single digits, with a sizable headwind from Flipkart (Goldman Sachs estimates that Flipkart's total operating losses will be roughly $2 billion this year). Adjusted for the Flipkart headwind, EPS is expected to increase low-to-mid single digits.

Over the past few years, Walmart has materially changed its approach to capital allocation. As an example, new unit growth in the U.S. has been essentially nonexistent, with the store count marginally higher since fiscal 2015. That is expected to continue next year (10 net new units). Instead, the company is continuing to invest in its U.S. e-commerce business, including the addition of 1,000 pickup locations (to 3,100) and 800 delivery locations (to 1,600). Outside of the U.S., Walmart plans to add 300 new stores in fiscal year 2020, primarily in Mexico (Walmex) and China. On a base of roughly 6,000 International stores, that implies mid-single digit unit growth.

Globally, Walmart should end 2020 with about 11,600 units - only a few hundred units above where it was five years ago (to be fair, that's inclusive of divestitures in a few international markets). To put that in perspective, Walmart added roughly 3,000 net new units in the five years through fiscal 2015. Again, we've seen a meaningful change in how the company allocates capital, as well as lower CapEx spend overall (capital expenditures will be roughly $2 billion less a year in the five-year period through 2020 as compared to the five-year period through 2015).

In addition to changes in capital allocation, Walmart has made a number of notable strategic decisions as of late. In the past year, the company announced a deal to merge Asda with Sainsbury's in the U.K. (though concerns from the competiton regulator has put that deal in jeopardy), sold 80% of its Brazilian retail business, and paid $16 billion for a 77% stake in Flipkart, India's largest e-commerce platform. Management appears to be narrowing its strategic focus to a handful of markets where it expects to compete and win over the long run.

Conclusion

The first few years under McMillon's leadership were focused on stabilizing the core (U.S. brick and mortar). The company has succeeded on that front. At the same time, they invested to reaccelerate growth in the U.S. e-commerce business, both through organic investments and M&A (most notably Jet.com, but also smaller deals like Moosejaw, Modcloth, Shoebuy and Bonobos). Now we've reached the stage where the company is narrowing its strategic focus outside of the U.S., with significant changes made in the U.K., Brazil, China and India over the past couple of years.

The issue is that these investments are bringing significant operating losses onto the income statement. In addition, it's not clear when (or even if) those losses will slow. On the fourth quarter call, McMillon was asked when these losses will peak. His answer was telling:


"Preserving flexibility there is important, we have never let a digital transformation at this scale before. We're figuring this out as we go. But if there's an opportunity to be more aggressive given the total balance of the business, we would be thinking about that... I think what you've seen from us in the past will continue to some extent. It's impossible to predict the pace of it or the number. We'll just have to see at the end of the year how it will work out."



Walmart continues to aggressively invest in U.S. e-commerce. With the acquisition of Flipkart, it now appears committed to doing the same in India. The question is when we'll see a return on that investment. I don't know the answer to that question. What I have learned from watching Walmart over the past five-plus years is that this can - and likely will - take a long time. That may be the right decision for the long-term health of the business - but it's not the easiest thing to live through.

With the company expecting EPS of $4.7 to $4.8 per share in 2020, the stock trades at more than 20 times forward earnings. Looking ahead, I think a realistic expectation is low-to-mid single digit revenue growth, (hopefully) stable operating margins and a small benefit from repurchases. With those inputs they can deliver mid-single digit EPS growth, but I wouldn't expect more than that.

I give McMillon and the team much credit for what they've accomplished. That said, we are in the early innings of a major investment cycle to position the business for the future. With competitors like Amazon (AMZN) and big plans in nascent markets like India, the long-term ROI of this massive investment is uncertain. That's keeping me on the sidelines for now. I would consider owning Walmart (again), but the valuation would need to reflect a fair amount of pessimism on these investments. By my math, that's not the case with the stock trading around $100 per share.

Disclosure: None.

This article first appeared on GuruFocus.


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