Are Walmart's Headwinds Long Term or Temporary?

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Wal-Mart Stores  (NYSE: WMT  )  recently lowered guidance for the fourth quarter as well as the fiscal year. The company cited several reasons for the reduced outlook. Are those headwinds temporary or long term? After establishing answers to these questions, we can determine whether or not Wal-Mart remains a quality investment. Below is a list of headwinds Wal-Mart is facing. We'll also examine whether or not these headwinds are likely to have a long-term impact on the company.

Wal-Mart stated that weather was partially to blame for reduced spending throughout the fourth quarter, after eight named storms battered most of the country.

On one hand, this makes sense. Nobody feels like braving a blizzard to sift through a bin of old $5 DVDs or to buy a $4 t-shirt. On the other hand, Wal-Mart now generates the majority of its revenue via groceries. When the weatherman calls for a storm, it sends the masses rushing to the nearest grocery store as if the Center for Disease Control just announced the imminent threat of an unstoppable plague.

Therefore, those same winter storms that should have led to softening demand for general merchandise should have also led to increased demand for food items. In other words, using weather as an excuse, though potentially justifiable, isn't acceptable. Nevertheless, it's a temporary event. 

Reduced food stamp benefits
Approximately 20% of Wal-Mart shoppers use food stamps. In 2013, food stamp funding was cut by $5 billion. When 20% of your customers take a hit, it's going to have an impact. To make matters worse for Wal-Mart, further food stamp cuts are likely this year. The only way Wal-Mart could dance around this would be to lower prices, but this would cut into margins and negatively impact profits. Food stamp cuts are a long-term headwind.

Payroll-tax "increase"
Contrary to popular belief, the payroll tax wasn't an increase. It was actually the end of a payroll-tax holiday. Prior to 2011, the payroll tax was 6.2%. In 2011, it was reduced to 4.2% in an effort to help low- and middle-income consumers weather the recession, temporarily. The payroll tax was supposed to end on Jan. 1, 2012, but it was extended an extra year. The payroll tax reverted back to 6.2% on Jan. 1, 2013, and though it's not often brought up anymore, it impacts most consumers. Wal-Mart had no problem performing well prior to the payroll-tax holiday, but people got used to easy, and that's never a positive when reality returns to the fold. Therefore, the payroll-tax "increase" is a long-term headwind. 

Online retail
As if Wal-Mart doesn't have enough problems to contend with, it must battle online retailers, especially  (NASDAQ: AMZN  ) . Amazon recently missed expectations, but this had nothing to do with actual results, which showed continued top-line growth. The problem for Amazon is a lack of consistent profitability. The company is considering increasing the price of its Amazon Prime service by between $20 and $40. As of right now, it costs $79 per year.

If Amazon increased its Prime membership by $40, a significant backlash would be possible, which would lead to temporary market share gains for Wal-Mart. However, if this took place, then Amazon would immediately backpedal, just as Netflix did in 2011 when it increased its membership fees by 60%.

As of right now, Amazon Prime has approximately 20 million members, and based on continuous reports of superb customer service and happy customers, this number is only going to increase going forward. This is bad news for Wal-Mart.

Wal-Mart currently offers free shipping for orders of $50 or more, but Amazon offers free shipping for orders of $35 or more. And if you're a Prime member, then shipping is always free. Of course, more people shop online today than in the past, which is a negative for Wal-Mart on the brick-and-mortar side.

On the other hand ... Wal-Mart "To Go" offers food delivery and in-store pickup, which should give it a significant edge over AmazonFresh. In-store food pickup is the key for Wal-Mart since, as of right now, it's not something Amazon can offer, and the food is guaranteed to be fresh. All that said, online retailers like Amazon are a long-term threat.

Dollar stores
Family Dollar Stores  (NYSE: FDO  )  recently warned of an earnings decline for 2014, with expected earnings per share of $3.25-$3.55 compared to $3.83 last year. Family Dollar also announced that December comps declined 3% due to fewer customer transactions. Consumables jumped 4.7% year over year in the first quarter, but Family Dollar seems to be having the same problem as Wal-Mart -- its customers are hurting.

Dollar Tree Stores  (NASDAQ: DLTR  )  targets the same consumer, but it's working on a number of initiatives. It's expanding its store sizes to allow more space for consumables (a key growth driver), it has a pricing advantage (consumers more attracted to $1 on all items), it's remodeling and relocating stores to maximize long-term potential, and it's investing in an omnichannel approach (catering to consumers in-store, online, and on mobile devices). Dollar Tree has also seen comps growth for seven consecutive years. And don't forget Dollar General, the largest dollar store of the bunch. 

Overall, the dollar stores, especially Dollar Tree, pose a threat to Wal-Mart over the long haul. But Wal-Mart is fighting back with smaller-format stores like Walmart Express (very early stages). Given Wal-Mart's cash flow generation and available capital to reinvest in its business, this could mean trouble for the dollar stores. 

The dollar stores are a long-term threat, but Wal-Mart is capable of winning back market share. 

The bottom line
Wal-Mart is facing a multitude of long-term headwinds that should prevent it from seeing significantly improved top-line growth. That said, there is future growth potential via its "To Go" food service and smaller format stores. In the meantime, Wal-Mart generates massive cash flow and consistently returns capital to shareholders, which still makes Wal-Mart a good value play. Please do your own research prior to investing.

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Dan Moskowitz

Dan Moskowitz spends the majority of his time researching stocks. He believes that fundamentals, and logic pertaining to industry trends, win out over the long haul.

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