Wal-Mart Stores, Inc. (NYSE:WMT) issued a downbeat outlook on Thursday, and Walmart stock sold off as a result. But WMT bulls know patience is a virtue as the company implements its turnaround plans.
WMT is curbing its capital spending plan while making investments in e-commerce and employee wages. It’s not a new strategy, and it was expected to be a drag on earnings for a number of years.
Sure enough, Walmart predicts that next year’s earnings per share will be flat compared with the current year. For fiscal 2017, WMT earnings are pegged at $4.29 to $4.49 per share on a net basis. Adjusted earnings (which is what Wall Street cares about) are targeted at $4.15 to $4.35 per share. Analysts were looking for adjusted earnings of $4.34 a share this year and $4.48 a share next year.
If a company issues an outlook below Street forecasts, it’s going to sell off. Fair enough.
But Walmart is looking farther out than just 2018.
Walmart Has to Adapt to Survive
Walmart is coming under increasing pressure from online retailers like Amazon.com Inc. (NASDAQ:AMZN) and is responding by pouring money into its own segment. Indeed, it recently committed $3 billion in cash to acquire Jet.com.
At the same time, it’s investing in sprucing up stores and the customer experience to compete with Target Corporation (NYSE:TGT). Walmart also is raising wages, and apparently the market didn’t account for the totality of those expenses in its earnings estimates. Capital expenditures are projected to be $11 billion next year as Walmart slows the rate of new stores and invests in making the extant store base more attractive.
WMT is trying to rely more on margin expansion and less on driving growth by adding new locations. The idea is that same-store sales growth and gains in e-commerce can boost the top line more profitably in place of additional bricks and mortar.
It’s a credible strategy, but risky. It’s also going to be a while before Walmart stock holders figure out whether it’s working or not.
Staying Frosty With Walmart Stock
The market isn’t dismissing the possibility of success, but it’s not giving Walmart the benefit of the doubt, either.
Just look at Walmart stock, which flattened out in July following a multi-month rally. That’s not really a shock with WMT gaining 17% for the year-to-date. At their peak, shares were up more than 20% in 2016. A pause after such a run isn’t abnormal.
It’s also probably the case that WMT’s valuation needs to cool off a bit to lure in patient value investors. By Walmart’s new earnings forecast, it trades at about 16 times forward earnings. That’s much cheaper than the S&P 500, but still above its own longer-term average.
It’s worth noting that the last half decade mostly precedes ongoing turnaround efforts. At any rate, WMT stock has an average forward price-to-earnings ratio of 14.5 for the past five years. Based on that, shares may have to lose a few more percentage points to make the valuation compelling.
That wouldn’t be a disaster.
As Walmart’s lackluster forecast shows, this is a story that extends beyond next year. And we always knew this was going to be a long game. If it weren’t obvious enough, WMT told us so itself. We’re talking years.
If Walmart can pull it off — and so far the results are promising — you can bet that a more optimistic market will be happy to give shares a little multiple expansion. For now, they’re likely to trade sideways.
But it’s reasonable to assume that down the road, Walmart stock will be trading at a higher price than it is today.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
