Keith shorted WMT in Hedgeye’s virtual portfolio with the view that inflation will become an increasing headwind for the company’s topline as well as for margins. Independent of inflation, we’re already pre-disposed to be short WMT based the internal challenges the company faces to drive its domestic same store sales towards the first increase in seven quarters.
The situation surrounding Wal-Mart’s internal execution in areas such as apparel and overall category management is nothing new. Too much selection? Not enough selection? Brands? Basics? Management is hyper focused on turning things around, yet numerous strategy changes over the past year have yielded little in the way of tangible results. We do not see a meaningful and credible plan at this current time that suggest domestic sales can outperform an increasingly challenging backdrop for the company’s core consumer. In fact, the company entered 2011 with total inventories up 11% against a 2.5% increase in sales. Clearly not the “clean” start that instills confidence in the wake of rising costs and substantial volatility at the gas pump.
We remain concerned with the following near-term challenges:
- Management’s message now says the US goal of positive same store sales will “take time”. The CEO acknowledged that issues facing sales (and their customers) were bigger than they “initially expected”. Traffic is still a drag and likely to remain so given the law of large numbers that puts 1 in 3 Americans at a Wal-Mart each week.
- The company cut capex by $1 billion for this year, after slightly raising it at the October analyst day. While this is noteworthy because it shows some discipline towards capital preservation, we put the amount of the cut in perspective. At today’s share price, WMT can buy an additional 19 million shares which represents a mere .005% of shares outstanding.
- Inventories are high no matter how you slice it heading into this year. Total inventories were up 11%, total sales up 2.4% at year end. With a negative comp headwind, inventory pressure is likely to persist through the first half of the year leaving little chance for margin expansion. From a timing perspective, this then rolls into the second half of the year which is the most uncertain time from an inflation and price elasticity standpoint.
- The current four point plan aimed at fixing the US business is centered on price leadership, broad assortments, improved remodels, and focus on multi-channel. None of this is revolutionary, but rather basic blocking and tackling. Details surrounding these plans are also scant, at least as of 4Q reporting. The first point of the plan is most telling however. In order to maintain price leadership in a the wake of rising costs, we suspect WMT will be as aggressive as ever to protect its market share. At best, this caps margin improvement in the near to intermediate term.