Shares of Wal-Mart Stores Inc. (NYSE:WMT) rose sharply in response to the company’s Q4 earnings report, but investors should consider fading the rally in WMT stock.
While the market loved the results, there were a lot of things not to love. Most importantly, Walmart’s earnings continue to compress, and the valuation continues to expand. This dynamic is making WMT stock unnecessarily risky.
With competitive pressures from companies like Amazon.com, Inc. (NASDAQ:AMZN) only intensifying, Walmart stock looks like a sell here.
There are some clear positive trends for WMT stock. Over the past several years, Walmart has had difficulty getting both traffic and average ticket to trend the same way — higher prices have resulted in lower traffic, and lower prices have resulted in higher traffic. This is natural for a department store with a particularly price-elastic audience.
It is encouraging, then, that WMT has managed to report three consecutive quarters of gains in both traffic and average ticket. Competition remains stiff, but Walmart appears to be stealing back market share from the dollar stores.
Importantly, Walmart is regaining this market share without slashing prices.
Moreover, Walmart’s online grocery business continues to grow, with pick-up service expansion driving most of that growth.
There are signs that market food deflation, which negatively impacted WMT food comps by roughly 90 basis points in the quarter, is turning the corner. That is a natural tailwind for further Walmart grocery gains. Prices at the pump are also rising, and that added 70 basis points of comp growth at Sam’s Club in the quarter.
Why I Am Avoiding WMT Stock
Overall, there are several near-term trends which look favorable for Walmart’s business. On the surface, WMT’s gains make sense.
Beneath the surface, though, is an ugly truth about Walmart’s underlying business performance: Walmart is making less and less money, and the trend isn’t reversing.
Walmart’s operating income was down to $22.8 million this year, from more than $27 million in fiscal 2015, and is guided to be even lower next year. That is a huge operating income decline of almost 20% in three years. Earnings per share, meanwhile, have fallen from $5.07 in 2015 to $4.32 last year. WMT management is guiding for further compression with $4.30 in fiscal 2018.
As opposed to Walmart stock falling, though, the valuation has instead grown richer. Over the past five years, WMT has traded right around 15 times trailing earnings. Today, the stock’s price-to-earnings multiple is over 16.5 (a 10% expansion). That inherently means there is more risk in Walmart’s valuation today then there has been over the past five years. Is that justified? Where is the growth going to come from?
This is where the bulls raise their hands and tout Walmart’s e-commerce growth potential.
E-commerce sales did pop an impressive 29% in Q4, but Walmart still missed consensus revenue expectations. Total revenue only grew 1% in the quarter, and is expected to grow only 2% to 3% next year. In other words, Walmart e-commerce may be on fire, but even exceptional e-commerce growth is only spilling into low single-digit revenue growth.
Investors also shouldn’t get too excited about Walmart’s free two-day shipping program on orders of $35 or more.
Management said early traction was positive, but this isn’t Walmart’s first rodeo with an Amazon Prime rival. In 2016, Walmart launched ShippingPass, a $49 paid subscription which guaranteed free two-day shipping. Despite the program’s huge discount relative to Amazon Prime (which costs $99), Shipping Pass never took off.
Scrapping the subscription fee and lowering the free shipping threshold likely won’t change much for Walmart. Investors should remember that WMT has to compete with an all-in-one bundle offering from Amazon that offers free shipping in addition to music and video streaming services, photo storage, and more.
Besides, Amazon just lowered its free-shipping minimum to lash back at Walmart.
Bottom Line on Walmart
Without growth on the top line, WMT’s valuation doesn’t make much sense at these levels. Due to heavy e-commerce investments and wage hike pressures, Walmart has been unable to lever expenses. As long as revenue growth remains minimal, so will profit growth. Analysts see less than 3% annualized earnings growth over the next two years, but Walmart stock is trading at 16.5 times trailing earnings. Meanwhile, the S&P 500 is trading at 21.5 times trailing earnings, but on more than 11% earnings growth.
With the market trading at a much more attractive multiple relative to projected growth, it doesn’t make much sense to get behind Walmart here near 52-week highs.
All else equal, WMT stock looks like a sell here.
As of this writing, Luke Lango was long AMZN.
