Wal-Mart, Profits Shrinking, Bets Big on Buybacks Rather Than Growth

Wal-Mart’s 2016 net income was $14.7 billion, over a billion dollars less than the prior two years which was a billion less than the year before, 2013.

Full disclosure: I don’t like Wal-Mart. Their relentless push to commoditize destroyed countless local stores and small brands that sold through those channels. Their employee compensation stinks except at the C-Suite. Their stores are depressing to visit. I don’t currently live in the US but, back when I did, would go there with visitors from foreign countries who wanted to see what it looked like, an anthropologic exercise.

Founder Sam Walton’s billionaire heirs donated essentially nothing to their own Walton Family Foundation which has about $2 billion in assets thanks to tax shenanigans. Family values. They did support Hillary over His Orange Highness, despite that they normally support Republicans, but that just shows they’re not psychotic. Besides, Hillary used to act like she is from Arkansas and even had the accent. Alas, I digress.

Besides Wal-Mart’s $14.7 billion profit they have $6.9 billion in cash. There is $198.3 billion in assets and $118.3 billion in liabilities so, unfortunately, they’re not going bankrupt anytime soon. They also collected $485.9 billion in gross revenue, an enormous amount of cash. Financials show a five-year R&D investment of zero.

Wal-Mart announced a $20 billion stock buyback and the market went bananas, bidding their stock up about 4.5 percent. Investors must assume that buybacks are going to get customers flying through the front doors somehow.

OK, I’m honesty not sure investors why are so enthused. Wal-Mart has bought back $95.7 billion (inflation adjusted) of their own stock, $19.3 billion of that in the last five years alone. The company is not new to stock buybacks.

But are buybacks for Wal-Mart a good idea? They claim to be making leaps in eCommerce but those claims feel hollow. Everybody knows the top three eCommerce companies are, in order, Amazon, Amazon, and Amazon. Now that Amazon is buying physical stores they can ring up more of the relatively low-margin grocery business that makes up a lot of Wal-Mart revenue. While Wal-Mart is buoyed by their 4.5 percent bump it’s more than offset by a 6 percent drop in June after Amazon announced their Whole Foods acquisition. Amazon is so far ahead in eCommerce that Costco’s stock went down when they announced a new eCommerce initiative: investors don’t like even the thought of competing with Amazon.

Rather than trying to compete with Amazon or buying back their own stock — on track to become the next Sears — why doesn’t Wal-Mart try something different?

It’s a radical idea but how about, as a start, making the stores a pleasant places to visit and work. Invest in infrastructure and employees instead of stock buybacks. Do something different in eCommerce rather than sell the same range of cheap stuff. There is still eCommerce innovation: Alibaba’s AliExpress is, if nothing else, different.

Wal-Mart’s revenue is still much higher than Amazon’s; they sell a massive amount of merchandise. But buying that stuff in a Wal-Mart store remains a serious pain point. To shop at Wal-Mart, the way most people do, first, drive to a store. Park. Deal with the “greeter” — a security guard — and the grunge. Walk around to search for whatever it is you’re looking for under harsh lights. Their employees look oppressed with the creepy dated blue vests. Wait in line to checkout. Bag your stuff. Carry it back to the car then from the car to your house. The experience has the personalization, comfort, and warmth of a DMV, a machine that craps you out with a little more stuff and a little less money than when you walked in.

Buybacks are theoretically for companies that have nothing better to do with their money. Apple, with their $260 billion stash, is an example. But even Apple could, and probably should, buy a European carmaker, avoiding the repatriation problem while fulfilling their strategic desire to create an iCar (and still have a bundle leftover).

Unless the corporate treasury is literally overflowing, Apple-style, managers who say they have nothing better to do with the corporate treasury than buyback their own stock are either incompetent — unable to create new businesses — or dishonest. In either case good corporate governance demands that Board’s have a responsibility to find better managers.

It is unfathomable to believe that Wal-Mart, with declining profits and increasing competition, has nothing better to do than spend an entire year’s worth of profits plus their entire cash reserves buying their own stock. Before their buyback bump Wal-Mart was trading at $79. Five years ago Wal-Mart was trading at $75.81. It’s also impossible to believe that management thought the stock is currently discounted. If anything their relatively flat share-price has escaped the retail armageddon but won’t forever: it’s overvalued, even before the buyback announcement.

The only believable narrative is that Wal-Mart executives do not know what to do about Amazon so they’re buying time and bumping their own bonuses with a pathetic buyback. OK, there is a certain poetic justice in watching Wal-Mart writhe in the same cauldron of disruption they dished out to local stores way back when but that doesn’t mean they shouldn’t at least try to genuinely grow their business rather than play games to jack up EPS.

Prof. Robert Ayres and I proved that the higher a ratio of inflation-adjusted buybacks to market cap results in lower long-term growth. Before this latest announcement, Wal-Mart purchased $95.7 billion. When we ran our study, Wal-Mart had a market cap of $227.7 billion, a 42% ratio of buybacks to market capitalization. Not bad, especially for a retailer; they’re one step above lackluster McDonald’s. But as their market cap declines along with that of other retailers, and their buyback program increases, they can easily slip into the danger zone, a high growth to market cap ratio that signals slower growth.

It’s unclear whether Wal-Mart’s Board asked CEO Doug McMillon if there really weren’t any growth opportunities for the company before agreeing to the buybacks. Whether Wal-Mart might create better long-term value for customers, employees, and shareholders by  investing the $20 billion in something more interesting than buybacks? I’m virtually certain this conversation never took place, which is almost as depressing as shopping at Wal-Mart.

Author: Michael Olenick

www.olen.com

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