In this segment from the MarketFoolery podcast, host Chris Hill and Motley Fool analyst David Kretzmann dig into the details of Walmart's (WMT -0.26%) latest quarter. The retail giant outperformed on profits and revenue, and its e-commerce business continues to grow faster. But as it shifts resources into moves like its $16 billion Flipkart deal, its gross margin is shrinking, and it's going to keep feeling pressure on that score.
The questions that most investors need to be answered, though, are these: Is the underlying state of the business better or worse than the stock value would indicate, and where does it go from here? The Fools weigh in.
A full transcript follows the video.
This video was recorded on May 17, 2018.
Chris Hill: Let's start with a much bigger shop, and that's Walmart and their first quarter results. The headline for Walmart was great, profits and revenue coming in higher than expected, online sales in the U.S. continue to climb. You look under the hood, though, and their gross margins are going in the wrong direction.
David Kretzmann: Yeah, this is a company really reinvesting back in the business. I think the headline this quarter, besides the e-commerce growth, which picked up from the previous quarter -- e-commerce up 33% this quarter compared to, I think, 23% the previous quarter. That's a strong number, but I'd say the headline this quarter is definitely the Flipkart acquisition that they announced within the past couple of weeks. Walmart making a huge $16 billion acquisition to acquire not even the entire company of Flipkart. They're getting 77%. So, I think you'll continue to see pressure on margins going forward as the company really reinvests back into their e-commerce business, the omnichannel experience. And then, internationally, Flipkart isn't going to be making money any time soon, so you'll see pressure on margins there as well.
Hill: Doug McMillon has been CEO for a little more than four years, and during that time, the stock is up somewhere in the neighborhood of 12%, something like that. That's not great, when you compare it to the market in general. But, I look at the state of Walmart's business, and it seems to me like it's more than 12% stronger as a business than it was four years ago, when you think about, not just Flipkart, but the jet.com acquisition and how that's worked out. I'm not saying, "This is a coiled spring that's going to take off in the next couple of years," but I really do feel like the underlying business of Walmart is in so much better shape than the stock performance indicates.
Kretzmann: Yeah, I would agree to an extent. I think the issue here is, even though they're plowing a lot into e-commerce, it's still not really at a level where it's going to be moving the needle to a meaningful degree. Total sales for the company were up 4.4% this quarter. You have some international sales that are growing well over 10%. But the U.S. business, for the most part, is very much established. They are seeing traffic and check growth, so same-store sales are still strong in the U.S. But, for the most part, this is still a slower growth story.
But, ideally, if you're a Walmart investor, you're hoping that the company's investments internationally into Flipkart and new regions, and domestically here with jet.com and that e-commerce business, maybe that can pick up the growth rate. But, in the meantime, I think, expectations are still somewhat tampered. They're going up against Amazon. As you mentioned, margins are pressured as a result. But, the valuation also isn't out of this world.
I think they're making the right moves. What gives me a little bit of pause is their capital allocation. The underlying business, like you mentioned, is still very strong, generating about $18 billion in free cash flow each year. But they're still allocating a lot of that to buying back stock and paying out a dividend. So, about $14 billion of that $18 billion in free cash flow is going to buybacks and dividends. I sort of wonder if they should maybe tamper down the buybacks and focus on these acquisitions, opening new stores, those capital expenditures, to improve the underlying business. That's what I would hope to see, is that they don't look to continue raising the dividend, they don't continue to buy back a ton of stock. Focus on reinvesting back in the business, because there clearly are growth opportunities in the retail space, online, and internationally. Focus there.
Hill: I think it'll be curious to see if they actually do that, because particularly with the Flipkart acquisition, that's one where they want to make sure it goes as smoothly as possible, and it's entirely possible -- look, any time a company makes an acquisition, more often than not, there are costs associated with it that aren't baked into whatever the final price tag was. Kind of like, I don't know, if you're doing a renovation on your home, it always ends up costing a little bit more. Or, you take your car to the shop, it costs a little bit more than you originally thought it was going to. And it seems like it would behoove them to listen to your advice. I think the Flipkart acquisition was a smart move, but they're going to need a little bit more cash than they probably think.
Kretzmann: I think they should count on that. Really, any way you look at the Flipkart acquisition, they paid a rich price. Flipkart's a young company, still losing a good chunk of money. And they're not the clear-cut No. 1 winner. Amazon's nipping at their heels already. Amazon, allegedly, was interested in Flipkart, as well.
I think Flipkart is somewhat of a stepping stone for Walmart into India. Something I hadn't realized is, there are some pretty tough regulations for foreign retailers expanding into India. Up to this point, Walmart only has 21 physical locations in India. And really, that's due to a lot of regulations that are in place to protect local mom-and-pop retailers and producers. Essentially, on a brick-and-mortar level, Walmart can't operate at scale. They need to source the majority of their products from local mom-and-pop shops. So, you can't have that scale advantage where you can buy a ton of stuff in bulk and then sell it at a discounted price to consumers, like we know and love here in the U.S. You just can't do that in India if you're a foreign retailer.
But perhaps this Flipkart acquisition, if it does get approved in India, maybe that gives them a little bit more leverage to negotiate with the Indian government, maybe open up some more physical locations and build out both the e-commerce side with Flipkart, but also build out the physical and omnichannel experience.