thinking about Walmart (WMT)

On August 16th, WMT reported very strong 2Q18 earnings (Chrome keeps warning me the Walmart investor web pages aren’t safe to access, so I’m not adding details).  Wall Street seems to have taken this result as evidence that the company makeover to become a more effective competitor to Amazon is bearing enough fruit that we should be thinking of a “new,” secular growth WMT.

Maybe that’s right.  But I think there’s a simpler, and likely more correct, interpretation.

WMT’s original aim was to provide affordable one-stop shopping to communities with a population of fewer than 250,000.  It has since expanded into supermarkets, warehouse stores and, most recently, online sales. Its store footprint is very faint in the affluent Northeast and in southern California, however.  And its core audience is not wealthy, standing somewhere below Target and above the dollar stores in terms of customer income.

This demographic has been hurt the worst by the one-two punch of recession and rapid technological change since 2000.   My read of the stellar WMT figures is that they show less WMT’s change in structure than that the company’s customers are just now–nine years after the worst of the financial collapse–feeling secure enough to begin spending less cautiously.

 

This interpretation has three consequences:  although Walmart is an extraordinary company, WMT may not be the growth vehicle that 2Q18 might suggest.  Other formats, like the dollar stores or even TGT, that cater to a similar demographic may be more interesting.  Finally, the idea that recovery is just now reaching the common man both justifies the Fed’s decade-long loose money policy–and suggests that at this point there’s little reason for it not to continue to raise short-term interest rates.

Warren Buffett selling Wal-Mart (WMT)

Investment companies are required to file lists of their holdings with the SEC at the end of each quarter.  The latest such 13-F form for Berkshire Hathaway shows a buildup in Apple and airlines   …and the sale of virtually all of Buffett’s long-term holding in WMT.

WMT as icon

A powerhouse in the 1970s and 1980s, WMT has been a bad stock for a long time.  It had a moment in the sun during the market meltdown from mid-2007 through early 2009, when it rose by about 1% while the S&P 500 was almost cut in half.  Since the bottom, however, WMT has gained 40% while the S&P is up by 219%.

Wal-Mart isn’t an obviously badly run company.  It isn’t, say, Sears, or the Ackman-run J C Penney.  But it does have a number of impediments to achieving significant growth in earnings.  One is its already gigantic size.  A second is its focus on less affluent rural customers who were disproportionately hard-hit by recession and who have in many instances yet to recover.  There’s increased competition from the dollar stores.   And there’s Amazon, whose competitive threat WMT itself admits it played down for far too long.

My reaction:

old habits die hard.  Mr. Buffett built his career from the 1950s onward on the observation, novel at that time, that traditional Graham/Dodd portfolio investing techniques glossed over the considerable value of investment in intangible assets–brand names, distribution networks, superior business practices.  However, by the time I entered the business in the late 1970s, other people–me included–were beginning to adopt his methods.  So thinking about intangibles became part of the toolkit, rather than something special.  Then, of course, the internet began to erode the power of intangibles to stop newcomers from entering a business.  Mr. Buffett, like any successful incumbent (including WMT), has been slow to adapt.

WMT as metaphor for today.  WMT could become more profitable quickly if its heartland lower-income customer base could earn more money.  One way to do that would be to bar imported goods from the country, with an eye to creating manufacturing jobs in the US.  Of course, that would also destroy the WMT value proposition in the process.  So rolling the clock back to 1950 isn’t the answer, either for the health of WMT or for its customers.

Wal-Mart (WMT), economic indicator and investment

WMT and the economy

WMT is the largest retailer in the US (Costco (COST) is #2).  Despite its very large size, WMT has a distinct economic focus, one based in its roots as a chain of quasi-department stores for small towns.  About a third of its customers are relatively low income blue-collar workers, whose personal fortunes tend to be very highly linked to the strength of the overall economy.  Because of this, when WMT profits start to rise, as they have been over the past several quarters, it’s a sign that economic recovery is strongly rooted and has spread relatively widely.

WMT as an investment today

In the past, periods like this have also been good ones to own WMT shares.  Two factors, however, suggest to me that this time could be very different:

the dollar stores.  During recessions, consumers tend not only to cut back on expenditures but also to trade down, that is, to patronize less expensive retailers.  In the case of many WMT customers, that means turning to the the dollar stores, whose target  customer has been a single head of household who earns $20,000 +/- a year, who walks to the store and who visits several times a week.  During the last downturn, the dollar stores decided to shift their business model and expand their product offerings in hopes of holding onto their new, more affluent former WMT customers when the economy improved.  The industry has also consolidated into a smaller number of larger firms, to the same end.

As a result, WMT has new competition for the low end of its market demographic, a segment that becomes more important as customers who have traded down to WMT from, say, Target, return to their former niche.

–like many traditional retailers, WMT hasn’t paid enough attention to the internet.  Its recent decision to acquire jet.com for $3 billion+ is evidence that WMT realizes it has to play catchup.   I think jet.com’s most important asset is its innovative top management.  Whether it will mesh well with traditional WMT executives remains an open question.

Wal-Mart (WMT)’s earnings miss: significance?

the coview

Yesterday, WMT reported 2Q13 earnings results, which came in below company guidance.  WMT also revised down its expectations for the rest of the year.  That news followed a similarly disappointing result from Macy’s (M).

Media comment has interpreted these reports as signaling the domestic economic recovery is stalling out, that “pent-up demand” –catch-up buying resulting from purchases postponed during the Great Recession has finally been exhausted.  Now, the talking heads opine, the true “fragile” state of the US economy is finally being revealed.  This realization is why the stock market declined sharply yesterday.

why I think the consensus is wrong

This interpretation may turn out to be the correct one.  But it’s not the only way to look at things.  In fact, in this case, I think the media view is wrong.  Here’s why:

1.  Interest rates went up yesterday.  The 10-year Treasury reached a yield of 2.77% on Thursday; the 30-year, 3.81%.  Both are highs for the year.  In other words, the bond market isn’t seeing economic weakness.  It’s seeing strength that will eventually lead to the Fed raising interest rates.

2.  WMT’s main business is selling food and general merchandise for cheap in no-frills stores targeted at middle- and low-income households.

When Sam Walton started doing this some 40 years ago, WMT had the field to itself.  But success spawned imitators.  In particular, recently, and especially during the recession, the dollar stores have been taking market share away from WMT.  In a way, this a replay of the competition between mainline department stores and specialty retailers that emerged in the 1970s-1980s.

3.  During recessions, people change their buying patterns.  They put off buying big-ticket items.  And they trade down to cheaper alternatives for everyday necessities.  When recession ends, they normally trade back up.  For the affluent, that is already happening.  For average and lower-income Americans, as I read the results from manufacturers of staples, that hasn’t occurred yet.

4.  About 30% of WMT’s traditional customers are low-income Americans.  I read the WMT earnings report as saying that economic recovery hasn’t yet reached this part of the company’s customer base.

This, I think, is the real news in the WMT results.  I think the earnings miss is evidence in favor of the idea that high unemployment in the US is a structural phenomenon that low interest rates can’t cure.  Action by congress and the administration is needed, instead.  But suggesting this is opening a can of worms that talking heads–and the securities analysts who feed them information–would rather not touch.  Easier to say (counterfactually, in my view) that the overall economy is cooling off.

my bottom line:  as a citizen, I have a strong opinion on the structural/cyclical unemployment issue. I think WMT’s weakness is a company-specific issue, not a macroeconomic one.

As an investor, however, there’s no need to either have an opinion on this issue or to make your view a major feature of your portfolio.  Just avoid low-end general retail.

Look, instead, for niche retailers who are showing strong same store sales growth   …or avoid retail altogether.  There’s no rule that says you always have to have retail stocks in your holdings.

Wal-Mart (WMT): early February sales “a total disaster’

Wal-Mart executives’ emails

Last Friday Bloomberg published  a summary of internal emails from WMT.  In one of these the company’s VP of finance and logistics, Jerry Murray, reportedly wrote that this February has seen the worst start to a month he’d seen in his seven years with the giant retailer.  He characterized the results so far as “a total disaster.”

The remarks are noteworthy if only because WMT is the largest store chain in the US, accounting for about $1 in every $10 spent at retail.  But they’re especially eyebrow-raising because Mr. Murray’s tenure covers the entire Great Recession of 2008-09, none of whose depths apparently held a candle to this February.

What’s going on?

I don’t know.  But this story is worth keeping an eye on.  It’s also probably worth monitoring MWT’s earnings results presentation on Feb 21st.

WMT’s take

WMT singles out two causes:

1.  the tax on payroll income that’s intended to fund Social Security (we wish) was raised back from 4% to 6% on January 1st

2.  the fiscal cliff debate that occupies Washington for most of December mucked up the IRS schedule for sending out forms and processing tax returns.  WMT estimates the IRS would have distributed almost $20 billion in refund checks during January to early filers–instead of the zero that actually occurred.

crosscurrents

It’s possible, of course, that Mr. Murray is highly emotional and sends out hysterical emails to colleagues as a matter of course.  Let’s assume that’s not the case.  If so, as investors we’ve got to consider that:

1.  Ex the extremely wealthy, consumers adjust their spending depending on the overall economic situation.  As we saw in 2008-2010, during bad times families:

—–defer buying big-ticket items, like cars, refrigerators…

—–buy cheaper generic rather than brands, and

—–trade down from, say, grocery/department stores to discounters, from discounters to dollar stores, or from dollar stores to places completely off the publicly-traded-stock map–all depending on where the individual’s starting point is.

WMT was a relative loser in this process.

Now the reverse is happening.  WMT is getting back customers from the dollar stores–and losing them to more up-market venues.  Symmetry argues that WMT should be a winner from this trend.  Apparently not, however.

2.  About a third of WMT’s customer base is families with annual income that’s just a bit over half the national average.  For these families, the rise in the payroll tax means a hit to disposable income of about $50 a month.  Doesn’t sound like much.  But for people already living from paycheck to paycheck, this may mean significant belt-tightening, even though the nationwide employment situation is gradually improving.

In other words, WMT’s terrible, horrible, no good very bad month may be indicative of the lower middle class market segment it dominates, rather than of the US economy as a whole.

what I think

No conclusions yet, only that the situation bears watching.

The sales falloff may be WMT-specific, the result of some merchandising mistake the company made.  It could also be indicative of the continuing struggles of lower-income Americans.  We also can’t dismiss out of hand the possibility that the overall retail business in the US is beginning to wobble as WMT apparently is–although I’d be very surprised if this is so.

As an aside, we might also ask how Bloomberg ended up with the emails–though my guess is that this isn’t that important for us as investors.

We’ll know more when WMT reports.

 

 

Thanksgiving weekend shopping reaffirms a recovering US consumer

the National Retail Federation survey…

The National Retail Federation released the results of its annual Thanksgiving weekend shopping survey, consisting of interviews of 4300+ consumers, yesterday.

The headline results are:  bigger crowds, $45 billion spent–up about 9% year on year.

The actual survey results, also available on the National Retail Federation site linked to above, contain more interesting information, namely:

–people traded up.  Shopping at discount stores dropped from 34.2% of the respondents in 2009 to 40.3% this year.  In contrast, department store shopping rose from 49.4% to 52.0%, and specialty retail store patronage grew from 22.9% to 24.4%.

–the types of gifts shifted from necessities to discretionary items.  For example,

—–14.3% of respondents said they bought jewelry last weekend vs. a low of 9.6% in 2007, 10.9% in 2008 and 11.7% in 2009

—–33.6% bought books, CDs, videos or video games vs. 41.7% in 2007, a low of 39.0% in 2008 and 40.3% in 2009

—–24.7% bought gift cards/certificates vs. 21.0% in 2007, a low of 18.7% in 2008 and 21.2% in 2009

—–of economically sensitive spending areas, only housing-related (home decor and furniture) is a significant laggard.  Among survey respondents, 20.2%  are spending on this category this year vs. 19.6% in 2007, 20.3% in 2008 and 19.9% in 2009.

–a third of all purchases, by dollar value, were online, with 33.6% of respondents saying they had shopped on the internet.

Many news sources, the New York Times, for example, are reporting that shoppers were also buying things for themselves rather than just holiday gifts for others.

…adds to the evidence of a healthier consumer

Over the past several days, other positive consumer indicators have been announced.  Last week, the Labor Department reportedThe Thompson Reuters/University of Michigan survey of consumer confidence hit a five-month high, although the release itself makes for pretty dismal reading.  While respondents may be feeling more secure now than for almost half a year, they expect the unemployment rate to stay high and salary increases to stay low.

investment implications

For a long time, I’ve been writing that I think that the recovery of the US economy this time around would follow the pattern of the rest of the world (that is, industry improves first, consumer second) rather than the shape it has invariably had in the past, at least throughout my investment career (that is, consumer first, industry second).

Recent data, and especially the NRF survey, seem to me to be in accord with my view.  I read them as saying that finally, almost eighteen months after the economy low, the US consumer is beginning to perk up again.

Ex discount stores like WMT and TGT and home improvement outlets like HD and LOW,  this suggests retailers with significant US exposure may be becoming more profitable than the consensus expects.  Stocks whose main virtue is that the vast majority of their sales are outside the US, in contrast, may begin to lose their allure in Wall Street’s eyes.

It’s relatively easy to check any stock’s geographical revenue breakout (and maybe operating profit, as well, depending on the company).  It should be in the firm’s annual 10-K filing with the SEC, available on the agency’s Edgar website.

WMT, DIN: more signs of a stabilizing/strengthening domestic economy

the data

–WMT reported earnings before the New York open this morning.  While comp store sales in the US were down for the third fiscal quarter (ends in October), the company has seen sequential improvement in year over year comparisons for the past several months. And it expects comps to turn positive over the holiday season.

–DIN (Dine Equity, parent of Applebee’s and the International House of Pancakes) reported September quarter earnings on November 2nd.  On of the most striking aspects of the recent recession (to me, anyway) has been the reversal of a decades-long trend of American consumers away from preparing/eating meals at home in favor of take-out and eating in restaurants.  Applebee’s, which DIN acquired in 2007, had its comps turn negative in 2006–and stay there.  But third quarter comps for company-owned stores were +3.3%.  Franchisees’ were +3.8%.

It’s not just Applebee’s.  According to the Financial Times, a trade source, the Knapp Track Report, shows the casual dining industry has been comping positive for about four months.  This is the first time since 2006 this has been happening.

–ATVI recently released its latest enter in the Call to Duty series, named Black Ops.  Black Ops had sales of $360 million in the US and UK during its first day (5.6 million copies).  That’s a video game record, and about 20% higher than first-day sales of the mega-hit Call of Duty:  Modern Warfare 2, which was last year’s entry.  Gamers tell me MW2 is the better game.  What’s changed is the economy.

–In its recent earnings call, DIS reported that bookings for its theme parks and resorts were up 5% year on year so far in the fourth quarter, at rates that were 5% higher than a year ago.  It’s a small thing, but higher room rate normally produces lower occupancy, as DIS’s results over the last year illustrate.  The idea is to trade the two variables off against one another in a way that makes revenue (rooms sold x room rate) the highest.  It’s a significant sign of strength when both metrics are moving up at the same time.

what this means

From early in the year, it has been clear that affluent Americans were beginning to feel their jobs were secure and that they could begin to spend a little more freely than they did in 2009.  In fact, sales of luxury goods have been surprisingly strong in the US recently (see my posts on the annual Bain luxury goods report).

These data suggest that everyday Americans have been adopting a similar, more positive outlook–probably starting in the summer.  They’re signs that people think their jobs are safe, that layoffs in their firms are at an end.

This conclusion is reflected in the latest Employment Situation report from the Department of Labor Statistics, which shows the US added about 159,000 private sector jobs in October, and which revised up the August and September figures to 143,000 and 107,000–a gain of 93,000 for the two months over the prior month’s estimate.

It seems to me the evidence points to the US having reached an inflection point where the economy is beginning to heal itself.  Slowly, it’s true, but healing nonetheless.  I’d read the 7%-8% drop in the 30-year bond over the past two weeks as the start of the process of normalization of interest rates, a process that will go on until the 30-year bond yields over 5% and the 10-year yield breaks through 4%.

For stocks, the situation will likely be more complex.  In the past, stocks have held up well during the post-crisis transition period (see my post from April on this topic). The critical question this time around, though, is what individuals do with the mammoth amount of money they’ve poured into bond funds over the past few years.  Do they simply stop allocating money to bonds for a while?  or do they actually withdraw funds?  Where does this money go?  I presume it makes its way into stocks.