Give Wal-Mart Stores, Inc. (NYSE:WMT) some credit.
After years of being asleep at the retail wheel, under the leadership of CEO Doug McMilllon, the company is finally responding to the biggest threat it faces: Amazon.com (NASDAQ:AMZN).
Over the past year or so, Wal-Mart made several decisions to make itself more competitive as retail shopping patterns shift. The company raised its minimum wage to $10/hour and revamped its training and promotion process in an attempt to improve store performance. The decision seemed to be a result of management's realization that operating a bare-bones business to keep prices down and squeeze out profits is no longer a viable long-term strategy. Wal-Mart's customer satisfaction scores have long lagged the industry, a sharp contrast to those of Amazon and rival Costco Wholesale, which rank at the top of the retail sector.
Wal-Mart also took the bold step of acquiring the start-up e-commerce business Jet.com for $3.3 billion last summer. Some critics derided the move, saying Wal-Mart overpaid for a company that was barely a year old, while others called it an "acqui-hire," implying that Wal-Mart bought the company just to bring founder Marc Lore on board. But Wal-Mart has deep pockets, and it needs to ramp up its e-commerce business as fast as possible. Already the move seems be having a positive effect, as Wal-Mart's e-commerce growth accelerated to 29% in the fourth quarter, up from just single digits earlier in the year. Strategically, the company is also becoming more aggressive as it unveiled free two-day shipping for orders over $35, a move that prompted Amazon to follow suit, lowering its free-shipping minimum to match Wal-Mart.
Since it purchased Jet, Wal-Mart has made some smaller e-commerce acquisitions and aggressively expanded its online grocery pickup program. The company also sharply scaled back new store opening this year in order to invest in its current store base and improve e-commerce operations.
Why it may not pay off for shareholders
The strategic shift is clear. Like Amazon, Wal-Mart is showing it's willing to sacrifice profits to build its business for the long-term. Profits shrunk this year due to the wage hike, and they are expected to remain flat. Management has projected them to grow modestly next year.
However, while becoming more like Amazon by embracing e-commerce, sacrificing short-term profits, and improving the customer experience is the right thing to do for the business, it may not do much to push Wal-Mart's stock higher.
That's because investors perceive the two stocks differently. Amazon Founder Jeff Bezos told investors he was building a company for the long-term from its inception. Though his business has put up scant profits throughout its history, investors have made it one of the most valuable companies on the market. Amazon has continued to hold a triple-digit earnings valuation as it has consistently delivered strong revenue growth, and developed valuable competitive advantages in areas like e-commerce and cloud computing that are expected to translate into profits over the years to come.
Wal-Mart, on the other hand, is valued as a traditional retailer. It carries a P/E ratio of 15, which seems fair for its growth prospects and competitive position. Wal-Mart's shareholders own the stock because it has been a reliable dividend payer, not for its growth prospects.
Amazon has earned the right to be treated as an exception. Wal-Mart has not. Even as the company transitions to challenge Amazon more directly, the stock is unlikely to move higher unless the company can demonstrate strong revenue or profit growth, which seem likely to be modest over the coming years even with the aggressive moves recently.
Making Wal-Mart's situation even more challenging is the near certainty that Amazon will continue to expand and enhance its operations. Wal-Mart may be paddling faster, but the water's only rising.
Amazon is constantly building new fulfillment centers to speed up deliveries, and the Wall Street Journal said the company had plans to open up as many as 2,000 grocery stores across the country over the next ten years. Amazon denied that story, but the company did unveil its new Amazon Go convenience store, with technology that precludes cashiers, in December.
Warren Buffett acknowledged Wal-Mart's challenges in a recent CNBC interview explaining why he sold nearly all of his stake in the company. Buffett called retailing "too tough," adding about Amazon, "That is a tough, tough, tough competitive force. Now Walmart is pushing forward online themselves. They have got all kinds of strengths, but I just decided that I'd look for a little easier game."
Investors may want to consider Buffett's wisdom. The upshot for Wal-Mart shareholders seems to be that the company will continue to make needed improvements, but it will likely be years before the stock sees a significant response to those efforts.