Two weeks ago Warren Buffett added 8.57 million shares of Wal-Mart (WMT 0.27%) to his Berkshire-Hathaway (BRK.A -0.63%) (BRK.B -0.52%) equity portfolio. This increase pushed the portfolio's total value of Wal-Mart shares to $4.4 billion, Berkshire's fifth-largest holding . However, Wal-Mart recently experienced a sudden drop in stock price which incited questions surrounding the company's long-term strategy .
A substantial increase of shares by the most successful investor of the 20th century may entice other investors to consider upping their holdings in the retail giant. Warren Buffett is buying Wal-Mart, but should you?
Is Wal-Mart done growing?
Earlier this month, Wal-Mart posted its fifth-consecutive quarterly decline in U.S. sales . Additionally, profit fell 5% compared to the first quarter of 2013 and store traffic continued to decline .
Most alarmingly, Wal-Mart's earnings per share dropped 3.5% in the first quarter of 2014. This drop followed a 20% drop in the final quarter of 2013, which marked the first time in 20 years Wal-Mart experienced a drop in earnings per share for two consecutive quarters.
Analysts are now claiming that these declines are due to a permanently broken business model. Some, like The Wall Street Journal's Shelly Banjo, say Wal-Mart is simply too big: consumers are no longer driving long distances to stock up on products. Instead, they are looking for closer stores and buying products to be used immediately. Smaller stores like Dollar General (DG -0.34%) and Dollar Tree (DLTR 0.59%) are eating up this growth.
These smaller stores focus on effective pricing to increase sales in an environment where consumers are holding back on spending. As a result, Dollar General and Dollar Tree experienced positive growth in same-store sales, net sales, and traffic in the past year. Bigger stores like Wal-Mart simply can't compete with $1.00 prices.
Dollar General and Dollar Tree also have better PEG's, 1.08 and 1.02, respectively, than the retail competitors of Wal-Mart, Whole Foods, Costco, Big Lots, and Target. This indicates these dollar-stores are currently undervalued and both stock prices should climb significantly due to future growth.
In contrast, Wal-Mart's struggle to create growth in same-store sales and traffic provides support for analysts' theory of the company as a dying business. The lack of short-term share price growth may not scare investors, but the sudden drop in important metrics should. Wal-Mart is a company of long-term viability with steady, albeit slow, growth. The recent declines in sales, traffic, and EPS have analysts like Shelly Banjo concerned about Wal-Mart's once-assured long-term viability.
Yes there are risks, but rest assured that Wal-Mart is not done growing.
How Wal-Mart gets bigger
Buffett is known for long-term commitment to his investments , which means he highly values potential future growth. Neighborhood Markets are the focus of Wal-Mart's strategy for future growth. These units are one-fifth the size of regular stores and are intentionally located near residential areas . These differences represent a shift to smaller and more local retailers in order to satisfy changing consumer preferences.
In the first quarter of 2014, Neighborhood Markets delivered a 4% increase in comparable sales and a 5% increase in comparable store traffic from last quarter. These increases capped a 46-month streak of positive comparables for Neighborhood Markets.
Encouragingly, Neighborhood Markets performed positively throughout the first quarter of 2014, despite heavy winter storms which handicapped most retailers and restaurants.
The positive performance of Neighborhood Markets lends hope to Wal-Mart's future growth strategy. Failure to identify changing consumer preferences spell doom for a company: just look at Sears Holdings. In the past 10 years, Sears attempted to save itself by continually shifting its business model. Now, the company has no connection with consumers and is contemplating a switch to shopper memberships in another attempt to find a successful business strategy. Unlike Wal-Mart, Sears has little hope for the future due to its ongoing inability to correctly adjust to the changing marketplace.
Another promising statistic for Wal-Mart's future growth revolves around its market share in groceries. The category of groceries makes up 56% of Wal-Mart's sales . During the first quarter of 2013, Wal-Mart gained 23 basis points worth of market share in the categories of food, consumables and over-the-counter food, which are parts of the larger category of groceries.
Continued increase in groceries market share, coupled with Wal-Mart's new line of organic foods, may indicate potential future growth. Consumers likely are not ready to walk away from Wal-Mart's big-box strategy yet. And neither is Warren Buffet.
Future outlook
The long-term viability of Wal-Mart hinges on its strategy for future growth. If its Neighborhood Market sector and groceries market share continue to show positive growth, then Wal-Mart may be able to stay relevant in a market of increasingly higher consumer time preferences. So far, the success of Neighborhood Markets validates a strategy of accelerated unit growth . As a result, Wal-Mart plans to make the Neighborhood Markets the fastest growing sector of the company. While the first quarter saw new supercenters outnumber new Neighborhood Markets, Wal-Mart is on track to open 180 new Neighborhood Markets this year, compared to 115 new supercenters.
Wal-Mart's traditional big-box stores recently stalled. However, Wal-Mart is an iconic brand, and its recent success in shifting to smaller stores looks promising. Furthermore, its increased market share in the company's highest revenue-earning category indicates possible future growth.
Do you trust Wal-Mart's strategy for long-term growth? Warren Buffett does.
