Wal-Mart’s Results Disappoint But Long Term Prospects Still Look Good

Retail giant Wal-Mart (NYSE:WMT) recently reported weak Q4 fiscal 2014 results and issued a bleak guidance for the current fiscal year. The retailer’s U.S. comparable store sales fell by 0.4%, marking the fourth consecutive quarter of comparable sales decline. The company’s sales were impacted by weak consumer sentiment in the U.S., adverse weather conditions and reduction in SNAP (supplemental assistance nutrition program) benefits by the government. Wal-Mart’s international growth remained slow due to foreign currency fluctuations, and sluggish economic environment in the U.K. and Mexico. In October last year, the company stated that it expects its overall revenues to grow by 3%-5% in fiscal 2015. ^[1] However, following weak fiscal 2014 results, Wal-Mart now expects sales growth to be near the lower end of its guidance. ^[2]

Despite the disappointing results and guidance, Wal-Mart looks well positioned to propel its long term growth. The retailer’s smaller format stores (Neighborhood Markets and Express stores) continue to register robust sales. Encouraged by this, Wal-Mart recently doubled the number of smaller stores it plans to open in fiscal 2015. The company even has an option of acquiring one of the dollar chains in order to boost its small store expansion. Also, Wal-Mart is investing aggressively in its online business, one that accounts for just 3% of its revenues presently. Due to its e-commerce channel’s immaterial size, the retailer wasn’t able to benefit from the recent surge in online orders in the U.S. However, with continued investments on this front, the scenario can change in the long term.

Our price estimate for Wal-Mart stands at $81, implying a premium of about 10% to the market price. However, we’re in the process of updating our model in light of the recent earnings release.

See our complete analysis for Wal-Mart

Small Stores Show Big Promise

During the fourth quarter, overall store traffic declined by 1.7% as Wal-Mart’s typical big-box stores struggled to attract customers. On the other hand, traffic in smaller stores continued to rise despite the extreme weather conditions. As a result, Neighborhood Markets delivered a compelling 5% growth in comparable sales during Q4 fiscal 2014. However, this was not enough to have a noticeable impact on Wal-Mart’s overall results. The company operates less than 400 smaller stores in the U.S. as compared to over 3,000 supercenters.

Traditionally, Wal-Mart has been serving customers who make less frequent stock-up trips. It hasn’t been as effective in catering to buyer needs for easy access, for which they usually go to a traditional convenience store. As a result, local convenience, dollar and grocery stores have been nibbling Wal-Mart’s low-end customer base. Expanding its smaller format network provides Wal-Mart with a great opportunity to win back those customers. By providing them with fresh inventory of food and consumables, the retailer can drive customers from alternative stores to its Neighborhood markets and Express outlets. Wal-Mart will utilize its large supercenters as “cross docks” to supplement the inventory needs of small stores.

The retailer is looking to expand these formats aggressively to continue its growth in the U.S. In October last year, Wal-Mart unveiled plans to open 120-150 small stores, and 115 supercenters in fiscal 2015. ^[1] This was the first time Wal-Mart U.S. was planning to open more small stores than its supercenters. Recently, the company bolstered its expansion plans and is now looking to add about 270-300 small stores in the U.S in fiscal 2015. We expect Wal-Mart to persist with this strategy for the long term, which will increase its smaller store count considerably. Considering that convenience chains operate close to 23,000 outlets in the nation, expansion potential is huge. We believe that over the course of next five to six years, Neighborhood Markets and Express stores network can become numerous enough to have a material impact on Wal-Mart’s results.

Wal-Mart Can Consider Buying Family Dollar

Although Wal-Mart is looking to expand its small stores aggressively, widespread network of dollar stores and space constraints in urban areas can be a roadblock. To prevent this, Wal-Mart can consider buying one of the dollar chains. Recently, industry expert and Credit Suisse analyst Micheal Exstein advised Wal-Mart’s CEO to acquire Family Dollar. ^[3] With Family Dollar’s market capitalization of $7.4 billion and revenues of roughly $10 billion, it would be a small transaction for Wal-Mart.  Given the dollar chain’s vast presence in the U.S. urban markets, this might be a good option for the retailer. Family Dollar is the second largest dollar chain in the U.S. with close to 7,500 stores. Out of all the three dollar chains, it has the minimum locations of store overlaps with Wal-Mart, which makes it the most viable acquisition option. According to Exstein’s report, only 19% of Wal-Mart stores are within one mile radius of a Family Dollar store. On the other hand, this figure is 29% in case of Dollar General and 49% in case of Dollar Tree. ^[4]

Buying Family Dollar will give Wal-Mart an already setup network of smaller stores with fewer concerns of self-cannibalization. Moreover, it will reduce the retailer’s potential competition considerably in urban markets. If Wal-Mart buys Family Dollar, its smaller format network can start contributing significantly a lot sooner. Since the company’s CEO is new, he might try to formulate some fresh strategies. However, buying a dollar chain is a big decision and it will be interesting to see if the company comes up with any such plans in the future.

Growing E-Commerce Business Is Looking Good

Apart from expanding its store base in the U.S., Wal-Mart is looking to leverage its existing presence to sell more online. The company is rapidly improving its mobile apps, and employing strategies such as ship-from-store, pay-with-cash, scan-&-go, same-day-delivery and crowd sourcing. It is also utilizing its big stores as fulfillment centers to ensure timely delivery of online orders. Last October, Wal-Mart expanded its online grocery sales (order online and pick from stores) in Denver and received compelling customer response. More than 90% of the customers rated the service between average and outstanding. ^[2] This indicates that Wal-Mart is slowly but steadily reviving the online grocery business, which has been a failure in the past for players such as Webvan. If the company manages to sustain its online grocery sales while expanding this service throughout the U.S., its e-commerce sales will increase considerably given that groceries account for over 50% of Wal-Mart’s revenues.

We do not expect e-commerce to become a big business for Wal-Mart in the near term, but these efforts are gradually pushing it in the right direction. Moreover, the optimistic outlook of the U.S. online retail industry somewhat ensures the retailer’s e-commerce growth. Therefore, we understand that online channel can become a valuable growth driver for the company in the long run.

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1. Wal-Mart predicts sales will grow faster next year, Reuters, Oct 15 2013 [↩] [↩]
2. Wal-Mart’s Q4 fiscal 2014 earnings transcript, Feb 20 2014 [↩] [↩]
3. Why Wal-Mart Should Buy Family Dollar, Financial Post, Feb 19 2014 [↩]
4. Analyst to Wal-Mart’s new CEO: buy Family Dollar to grow in the U.S., Market Watch, Feb 19 2014 [↩]