Walmart (NYSEARCA: WMT) is trying to keep up. In mid-October 2018, the retail giant announced it had acquired Bare Necessities, an online lingerie seller, for an undisclosed sum.
It is one of many online sites gobbled up by the big-box retail giant in order to expand its online footprint. It had already purchased Jet.com, a low-priced retailer that some find difficult to distinguish from Amazon. And then there’s MooseJaw, which sells outdoor gear; ModCloth, a seller of funky clothing for young women; Shoebuy, which is just what it sounds like; Bonobos, a menswear retailer, and Hayneedle, a home furnishings store. All are now owned by Walmart.
Walmart is never going to buy Amazon (NASDAQ: AMZN). After all, Amazon surpassed Walmart as the world's largest retail chain in June 2015. But it’s putting together a pretty substantial, if patchwork, online presence, one startup at a time.
That, plus a substantial redesign of its online site, pretty much addresses Walmart’s strategy to meet one of the big challenges facing the retail giant: The online retail revolution. In the 3rd quarter of 2018, the company’s U.S. online sales were up 40% for the quarter compared to a year earlier.
But what of the other big challenges facing Walmart?
One of Walmart’s big challenges is that, well, it’s Walmart. As of 2017, the company had 11,675 big-box stores around the world, in an era when big-box stores were in a long, slow decline. It has 2.2 million employees worldwide, by its own count. It stocks 60 million products.
Then again, the death of real-world retail may be at least slightly exaggerated. Walmart’s 2nd quarter 2018 report contained evidence that people are still showing up at its real-world stores. It reported its strongest growth in more than a decade at stores open for at least one year.
Some of that must be attributed to a zooming economy with the lowest unemployment rate in decades.
Market risks are the most generic risk category that any security faces, but the way they affect each company differs. For example, the manipulation of interest rates by the Federal Reserve has different effects on a bank like JPMorgan Chase and a food chain like Chipotle, while federal food regulations undoubtedly affect the latter more than the former.
Many of Wal-Mart's most significant market risks center on its global presence. One of the challenges of any business chain with locations in many countries is the cost of regulatory compliance in every one of those countries. Wal-Mart has to enforce difference workplace standards in China than it does in the United States and has to accept a greater degree of regulatory uncertainty.
Two prominent examples of regulatory risk arose in 2014 in China and 2015 in the United States. The Chinese government fined Wal-Mart the equivalent of $10 million for food safety violations, to which the company responded by revamping inspections, adding training programs and recalling certain products. All of these actions raise the costs of providing Wal-Mart's services, and shareholders bear some of those costs through lower share prices or less dividend income.
In 2015, political and economic pressure in the United States caused Wal-Mart to increase its minimum salary for employees. The company estimated that 500,000 individuals received an increase between $1 and $1.75 per hour and it would cost $1 billion in the first year.
Other important market risks include business cycle risk, interest rate risk, exchange rate risk, and intense competition from companies such as Target and Amazon. It's very difficult for an investor to price this risk into a decision on a stock, but they are still crucial variables when determining if it's worth buying Wal-Mart stock.
In early 2018, Walmart announced it would begin paying its employees at least $11, up from $9, and expand some employee benefits, as a way of sharing the wealth it gained from the federal tax cut on corporate income. It even handed out bonuses of up to $1,000 to its employees.
If employees were pleased about that, it might not last for long. For several years there has been widespread pressure to raise minimum wage rates to $12 or $15 an hour, and much of the pressure is coming from local states and cities where living costs are relatively high. Wal-Mart, which already suffers from lower earnings per share (EPS) than many competitors, would likely be forced to make major labor adjustments to survive such an increase.
The defining advantages of Wal-Mart superstores lie in low prices and favorable distributor relationships. Wal-Mart has historically kept prices low through relatively small input costs and excellent logistical management of overhead. In other words, the company acquires and offers more products at lower costs than everyone else.
Labor costs are a significant part of this equation but they might be changing.
Wal-Mart's profit margin is typically below 3%. Only three parties can bear the brunt of increased wage costs: employees through reduced benefits or layoffs, customers through increased prices or shareholders through lower share prices and fewer dividends.
Given competitive constraints, it seems most likely that employees and shareholders, not customers, would bear the brunt of a minimum wage increase.
Wal-Mart is always in litigation over something, and usually many somethings. It's one of the side effects of being in every market and selling just about every kind of product.
In October 2018, Walmart reportedly reached a preliminary agreement to pay $65 million to settle a class-action lawsuit from about 100,000 California cashiers who accused it of failing to provide seating during their shifts, in violation of state law.
In 2011, Wal-Mart was sued in Chicago courts for firing an employee who made controversial remarks about homosexuals. Later in 2011, Wal-Mart agreed to settle a class-action suit over a deal made with Netflix in 2005. A New Jersey citizen sued in 2012 for $1 million over alleged racist comments made in a Wal-Mart store. Wal-Mart was sued by New York City's pension funds. The company was sued over bribery and money laundering allegations in Mexico later that year. In 2013, Wal-Mart agreed to pay $81.6 million in damages over improper disposal of fertilizers. Pennsylvania consumers filed suit over too much tax being charged customers using coupons.
Sometimes Wal-Mart is involved in suits only as an incidental actor, such as in Burbank in 2012, when activists opposed to a new Wal-Mart store sued the city council over plans to break ground on a new store.
The company has been able to survive thus far, but there is no question that shareholders and customers eventually bear the brunt of costly lawsuits. This gives competitors an edge and raises concern over the long-term viability of the stock's dividend or return prospects.
The Bottom Line
Historically, Wal-Mart has been a conservative investment. Revenue seems stable and the company has paid dividends for decades. No stock comes without risks, however, and Wal-Mart faces some critical risks in the near future. Investors should consider these before holding or buying shares of the biggest private employer in the world.