Jubak's Journal Recent articles: • Let's talk trash: 5 post-hurricane picks, 10/5/2005 • 5 double-your-money tech survivors, 10/4/2005 • Airlines and the epidemic of risk, 9/30/2005 More... | Jubak's Journal Wal-Mart's pricey gamble The giant retailer hopes to solve its growth problems by targeting a new type of shopper. But investors should know: it's facing a dangerous year ahead. By Jim Jubak Wal-Mart is betting the store on a new strategy. If it works, the strategy will re-ignite growth at the mega-retailer and revolutionize retailing -- again. If it doesn't, doubts on Wall Street about Wal-Mart Stores' What are the odds that Wal-Mart will win its bet? No better than 50/50. Wal-Mart is proposing nothing short of completely re-inventing itself, and that's never easy. For every General Electric Most retailers would kill to have Wal-Mart's problem. Sales growth was 11.3% in 2004 and, before Hurricane Katrina slammed into the U.S. economy, researcher Value Line was projecting 2005 sales growth at 10.3%.
Which is none too shabby, unless you're Wal-Mart. Wall Street remembers the heady days of 1998 to 2000, when the company averaged annual sales growth of 17.5%. That's 70% better than this year's projected sales jump. An everyday low stock price The slower growth has created a huge problem for the stock: Investors have been steadily cutting the price-to-earnings ratio they're willing to pay for Wal-Mart's earnings because the company hasn't convinced investors it has a fix for slowing sales growth. After climbing from 21 in January 1998 to 44 in January 2000, the stock's P/E ratio has been in a steady decline, even as the stock market as a whole has recovered from the bursting of the bubble of 2000. Today, Wal-Mart's shares trade at a P/E of just 17.3, even though earnings per share are projected to grow by 14% a year over the next five years. Compare that to PepsiCo Related news and commentary on MSN Money
By giving Wal-Mart's higher projected earnings growth a lower price-to-earnings multiple, the stock market is signaling that it doesn't have a whole lot of confidence in those projections. If the projected growth isn't likely to show up, then who wants to pay for it? It's that skepticism that has led the stock to post a 17.2% loss in 2005, as of Oct. 5. For the five years that ended on Oct. 5, Wal-Mart's shares have returned precisely zero. A goose egg. Nada. Quite a turn for a stock that returned 295% for the prior five years from October 1995 to October 2000. (Although, I grant you, Wal-Mart did outperform the Dow Jones Industrial Average Why that skepticism? The company's recent results have earned it. For the second quarter, Wal-Mart reported its smallest quarterly earnings gain in four years, and the U.S. division missed its sales target for the second straight quarter. But the skepticism has deeper roots than just a couple of quarterly earnings misses. In the near term, Wal-Mart says higher oil prices mean less buying by lower income customers. Those customers, who have less discretionary income to start with, disproportionately cut their spending when prices climb at the gas pump. The company estimates that higher oil prices since the start of 2005 have cut same-store sales growth from a projected 5% to a 2%-to-4% range. Target-ing a new customer Unfortunately for Wal-Mart, that oil-price-related drop in same-store sales feeds right into a worry that dogged the stock even before oil prices soared this year. Growth in sales per store dropped from 8.7% in 2001 to 5.7% in 2002 to 0% in 2003, and then rebounded to 3.2% in 2004. Almost all of Wal-Mart's sales growth was a result of the company opening new stores. Store count climbed to 5,289 in 2004 from 4,906 the year before. And disappointing same-store sales growth wouldn't be such a problem if the company's costs hadn't crept up. Wal-Mart is unmatched when it comes to squeezing the last penny out of a supplier's price, and the company has become even more aggressive in the last two years about scouring the globe to find the cheapest supplier. Nonetheless, costs in a category called Sales, General and Administrative have been climbing as a percentage of sales revenue to 17.9% in fiscal 2004 from 16.3% in fiscal 1999. Three reasons: rising costs per employee, higher advertising spending (up 45% in 2004) and spending to improve the "fashionability" of its stores and the clothes that Wal-Mart sells. As a solution to its woes, Wal-Mart has come up with a radical change of direction. This strategy attempts to adopt some of Target's Wal-Mart Chief Financial Officer Tom Schoewe told investors at a Bank of America conference that it was now selling an 8-megapixel Canon digital camera for nearly $1,000. The company is opening a fashion observation post in New York's Garment District in order to stay on top of current trends. (This effort has already paid off: on Oct. 4, the Anthropologie unit of Urban Outfitters This strategy is plenty risky. Wal-Mart could manage to alienate its core lower-income customers by making them feel that the store no longer wants them. Wal-Mart could fail to attract the new market segment it wants because its new products are unfashionable, too stodgy or not edgy enough. Wal-Mart will have to spend more to upgrade stores, more on advertising and more on product intelligence and design, at a time when investors already are worried about rising costs. And there is certainly no guarantee that the company will be able to develop a fashion sense in apparel, electronics or any other category. It's not exactly in Wal-Mart's genes (or jeans, for that matter). A logistical-might scare The biggest risk, however, the one that makes this a bet on the company strategy, is that Wal-Mart pays so much attention to this new direction that it loses its focus on logistics, the area that has made Wal-Mart the retail powerhouse that it is. Because Wal-Mart's computerized system knows what everything costs, what everybody is buying, where they're buying it, how long a product sits on the company's shelves and how long it took to get there, Wal-Mart has been able to drive down costs and drive them down some more. Sure, Wal-Mart has huge sales volume -- at $285 billion in 2004, the company's sales are about as large as the 2004 GDP of Indonesia. But it's the ability to get the right information to the right place at the right time that allows Wal-Mart to put that clout to best use -- and that gave it the edge over competitors so that it could get that big to begin with. The challenge facing Wal-Mart isn't just learning a new trick but learning how to blend the new tricks of trend merchandising with its traditional strengths in logistics. The most dangerous period facing the company is probably the next year to 18 months. Costs will go up. The retail environment will remain tough. The results of the new strategy won't be apparent in same-store sales growth over that period. I mean, hey, it does take a while to get this new direction implemented when you run 5,000-plus stores. Wall Street will go nuts over some of the quarterly numbers and trends. Impatient investors could well push the stock down further for small offenses, like the normal missteps that come with executing any new strategy. If Wal-Mart management gets cold feet and reverts to current strategies or announces a new one, then the company will indeed have dug itself a much deeper hole. The problems it faces then will be just that much harder to fix. The upside, though, is potentially enormous. The next frontier in retailing is applying Wal-Mart-style logistics to trend-driven merchandizing. The company that can put out the fashion of the moment in an appealing store at Wal-Mart-like prices by sourcing the product at the best global price -- and then update each product with the same speed that Apple Computer The turf is still out there waiting for somebody to stake a claim and then build barriers of entry so high that no one can climb them. That's the potential in what Wal-Mart has set out to do with its new strategy. I'd say wait six to nine months. See the stock take some lumps on costs and a soft economy for retailers this winter, and then, if Wal-Mart has demonstrated that it's truly committed to this strategy, load up the truck and buy. If Wal-Mart wants to bet the company, the least we can do is go along for the ride. New developments on past columns 8 stocks for a wandering market On Sept. 30, PepsiCo Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Pepsico. He does not own short positions in any stock mentioned in this column. | |||||||||||||||||||||||||||||
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