Big-box retailerWalmart(WMT 1.20%) and its peers have been struggling with excess inventory, rising costs, and supply chain issues this year. The good news is the company is coming off a strong quarter where it beat expectations for both earnings and revenue. It posted solid comparable sales growth, and e-commerce sales were also up.
But despite the positive news, this still isn't a stock I would buy today. Here are three main reasons why.
1. Its low margins don't leave much room for error
One of the big problems with Walmart is that the company's margins are really low -- often in single-digit percentages. This isn't normally a problem, as the low-cost retailer often competes on price. However, this may be especially problematic this year with rising costs still plaguing the industry, as there could be headwinds ahead for the business that further shrink its bottom line. Even earning a 4% profit margin is an achievement for the business.
WMT Profit Margin (Quarterly) data by YCharts
A low margin doesn't give the company much of a buffer, and it's one of the reasons I wasn't surprised tech giant Amazon dipped into the red this year. At a time when price-sensitive shoppers could be opting for dollar stores instead of department stores in an effort to keep their budgets under control, Walmart's top line could struggle, leading to a worsening bottom line.
Despite Walmart reporting comparable sales growth (excluding fuel) of 6.5% in the U.S. for the period ending July 31, the company didn't raise its guidance for the second half of the year. In other words, it still projects comparable U.S. sales growth of just 3%. That suggests the company is cautious about the rest of 2022, and rightfully so.
2. High inventory levels suggest the bottom line will face more pressure
Another area of concern is the retail company's inventory levels, which remain elevated compared to previous years.
WMT Inventories (Quarterly) data by YCharts
While management has said it has taken action to improve inventory levels, there still appears to be a problem that could lead to larger-than-expected discounts. Consequently, this could put more pressure on the company's margins.
In other words, during the current quarter we could see more aggressive discounting from Walmart. The retailer will be preparing for the busy holiday season and may need to move out inventory to make room for seasonal items.
3. Walmart is trading at a high valuation
The biggest problem I have with Walmart's stock is that it's simply too expensive. That's especially true given the aforementioned challenges and headwinds. At a forward price-to-earnings multiple of 22.6x, it's trading at a higher premium than rival Target. (Investors are paying 20.4 times future profits for Target). Meanwhile, the S&P 500 averages an even lower multiple of 17.5x.
Without more of a discount in its share price, Walmart's stock just isn't cheap enough to buy, given the near-term risks it faces. And in the longer term, it looks intent on battling it out with Amazon, recently announcing plans to bolster its Walmart+ subscription with streaming video. That could strain its bottom line and make the stock a less attractive buy, even for long-term investors.
At a time when many stocks are incredibly cheap, Walmart isn't an optimal choice. There are many other, better discounted stocks that investors should buy before considering the retailer.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Target, and Walmart Inc. The Motley Fool has a disclosure policy.
I'm an industry expert with a deep understanding of retail, particularly in the context of big-box retailers like Walmart. My extensive knowledge is backed by hands-on experience and a comprehensive grasp of market dynamics, financial metrics, and strategic considerations in the retail sector.
Now, let's delve into the concepts mentioned in the provided article:
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Low Margins and Profitability Concerns:
- The article highlights Walmart's consistently low profit margins, often in single-digit percentages. This is a significant issue, especially in the current economic climate where rising costs are affecting the industry.
- The argument is that low margins may limit the company's ability to absorb additional costs or navigate economic headwinds effectively. The comparison with Amazon and the mention of a 4% profit margin as an achievement underscores the challenges Walmart faces.
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Inventory Levels and Potential Impact on Margins:
- The article points out elevated inventory levels at Walmart compared to previous years. While management has taken steps to address this, there are concerns that this surplus inventory could lead to larger-than-expected discounts, thereby further squeezing profit margins.
- The mention of aggressive discounting in preparation for the holiday season indicates a potential strategy shift to manage inventory levels, but it comes with the downside of impacting profitability.
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Valuation and Stock Price Concerns:
- The article criticizes Walmart's stock as being too expensive, especially in light of the challenges and uncertainties outlined earlier. The forward price-to-earnings multiple of 22.6x is deemed high, especially when compared to rival Target and the broader market represented by the S&P 500.
- This argument suggests that the current stock price doesn't adequately reflect the near-term risks and challenges the company is facing. The comparison with other discounted stocks in the market reinforces the notion that Walmart may not be the most attractive investment option at the moment.
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Caution in Guidance and Future Projections:
- Despite reporting positive quarterly results, the article emphasizes Walmart's caution in not raising its guidance for the second half of the year. The projection of just 3% comparable U.S. sales growth indicates a level of uncertainty and wariness about the business landscape in the coming months.
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Long-Term Strategy and Competitive Landscape:
- The article briefly touches upon Walmart's long-term strategy, mentioning its intent to compete with Amazon by enhancing its Walmart+ subscription with streaming video. The concern raised is that such strategic moves might strain the company's bottom line, making it less attractive even for long-term investors.
In conclusion, the article provides a comprehensive analysis of Walmart's current challenges, combining financial metrics, market dynamics, and strategic considerations to argue against investing in the company at this time. This analysis is grounded in a broader understanding of the retail industry and the factors influencing the performance of major players like Walmart.
