Walmart’s Margin Expansion and Emerging Market Growth Can Deliver Strong Returns

Key Takeaways

• Walmart is an industry leader deeply entrenched in the lives of millions of customers. 
• Using modern solutions like AI, Walmart can magnify these economies of scale advantages.
• A successful expansion to lucrative markets like India will provide the company with further growth.
• The dividend stability and growth will start to matter as the FED stops and eventually reverses the hike cycle.

Catalysts

Company Catalysts

Resilient Brand Strength And Innovation Aids Customer Retention

Walmart's brand has been around for decades. It is one of the most valuable retail brands that demonstrated consistent resilience over the years. Still, its intangible value is strengthening, more than doubling over the last decade, from $53 billion to over $113 billion. Successful automation and superior supply chain enabled Walmart to pass significant savings onto consumers and become an inseparable part of millions of households.

In recent years the management implemented various innovations including e-commerce services and AI-driven automation through a partnership with Symbiotic. Furthermore, Walmart successfully launched a membership program, strengthening its brand moat.

Ability To Leverage Economies of Scale Delivers Profit Margin Advantages

Walmart is the largest global retailer, operating 10,500 stores across 24 countries, with approx. 2.1 million associates. Around half of that is the domestic market, where the company is well-positioned to benefit from regional concentration. It has the highest number of stores (509) in Texas, which is the fastest-growing state economy.

It also successfully expanded internationally, particularly in India, a rising global power, where it acquired e-commerce firm Flipkart.

Due to its sheer size, Walmart's core strategy revolves around economies of scale and efficient logistics networks. By working directly with suppliers and purchasing in large quantities, it can undercut its competitors, ensuring pricing superiority in an industry with relatively low profit margins.

Impressive Dividend History Attracts Dividend Investors

As the FED raised interest rates, yield-oriented investors have been incentivized to seek returns from fixed income rather than equities. However, as the rate hiking cycle comes to an end and rates start turning back down (or so investors are anticipating), yielding equities like Walmart becomes more attractive.

Walmart's dividend history has been exceptional, as the company has increased its annual cash dividend every year since declaring its first dividend in March 1974.

Yielding at 1.5%, its dividend might not look impressive, but it is worth noting that the industry average is about the same. However, a 38% payout ratio indicates a strong buffer of safety and plenty of room for further growth.

Industry catalysts

E-commerce Growth is Still in Double-Digits And Walmart Can Reap The Benefits

Despite its already impressive size ($3 trillion in projected revenue in 2023), the e-commerce market is expected to grow to $5 trillion by 2028, or an annual growth rate of 10.15%. For the United States, this is attributed to expected user penetration of 80% to 93% by 2028.

Walmart, whose e-commerce sales rebounded over the last few quarters, can benefit from this growth with refreshed app & website design, automated solutions, and a growing marketplace – all of which can help them challenge the unprecedented leader, Amazon.

Currently, 15% of Walmart’s sales come from E-commerce, but I expect this to continue growing since its growth will be faster than in-person sales.

Strengthening Budget Consciousness Keeps Product Pricing Competitive

PwC's Global Consumer Insights Pulse survey has shown that 50% of consumers show concerns about their personal financial situation, while a staggering 90% have adopted cost-saving behaviors.

As the rising cost of living puts pressure on consumers, they respond by buying in bulk, buying retailers' in-house brands, and waiting for discounts. 

A further study from Morgan Stanley showed that 37% of shoppers were planning to keep their holiday budgets roughly the same, while 27% expected a decrease in spending. I believe this trend will benefit discount retailers like Walmart, Target and Costco and help drive sales growth by funneling cost-conscious shoppers to Walmart and away from more expensive competitors.

Assumptions

• I expect the retail industry to grow at 7.69% CAGR until 2030. Being an extremely large and mature company, I don’t expect Walmart to match that growth, but I expect it to achieve successful  expansions in foreign markets like China (with a stake in JD.com) and particularly in India, the fastest-growing major economy (Flipkart). 
• Given the uplift from this expansion in international markets and its ability to leverage economies of scale to draw cost-conscious shoppers away from competitors
• I expect the capital expenditures to remain stable at $16-17 billion, geared towards efficiency rather than growth, which will help the margins improve.
• I believe that the ongoing headwinds like theft and diet trends won't hurt the bottom line. I expect the positive AI catalysts to drive the margin increase – expanding the net margin to reach 4% over the next 5 years, up from 2.6% today.
• I anticipate Walmart’s revenue to grow at 4.5% annually over the next 5 years to 2029, slightly above analyst’s consensus.
• I expect the stock buybacks to continue at a stable pace, reducing the share count by approximately 2.1% per year.
• I expect the company not to add a significant amount of debt during the period of higher interest rates, keeping the debt constrained within the long-term range of $40-$55 billion.
• I expect a future price-to-earnings ratio of 23, which is slightly below the current and represents the long-term average.

Risks

Retail Theft Issues Hurt Margins

Retail theft, particularly organized retail crime (ORC), poses a significant challenge for major retailers. The impact on their bottom lines has prompted CEOs to address the issue, with losses amounting to $112.1 billion in 2022, according to the National Retail Federation. 

ORC involves criminal enterprises stealing large quantities of merchandise for financial gain, affecting not only individual stores but the retail industry as a whole.

While retailers have implemented various strategies, such as increased surveillance and old-school loss prevention measures, the rise of self-checkout introduces new complexities. The blurred line between customer mistakes and intentional theft makes it difficult for retailers to discern the root cause. 

As a result, the challenge in combating retail theft lies in finding effective solutions without inconveniencing law-abiding customers. The reliance on self-checkout and the potential impact on in-store shopping convenience could drive consumers to online retailers like Amazon. 

Retailers may need cooperation from local authorities, implementing both technological solutions and strategic merchandising approaches to minimize theft. 

Should Walmart fail to implement adequate theft-deterrent strategies, they risk hurting their profit margins in addition to losing out on market share to Amazon if the retail experience becomes too cumbersome.

Weight Loss Trend Hurting Retail Consumption, Potentially Harming Grocery Sales

The obesity epidemic in America, affecting 42% of the population, presents a significant public health challenge. Weight loss drugs like Ozempic have been gaining popularity and threatening to cut retail sales due to reduced calorie intake.

Barron’s reported that Bank of America analysts estimate a potential 1% to 3% reduction in the nation's total calorie consumption by 2030 if 25 to 50 million Americans adopt these drugs. 

While some analysts suggest that the impact on industries is manageable through innovation and portfolio reshaping, concerns persist about the economic repercussions on restaurants, snacks, and soda sales. If this trend becomes significant, Walmart’s food sales could drop, lowering overall sales revenue.

International Expansion Faces Geopolitical Uncertainty

Walmart's domestic market is mature and saturated. Thus, the company has to look into foreign expansions like Latin America, China or India, since these emerging markets are growing at a much faster pace.

However, the world is currently facing the largest wave of polarization since the Cold War, with active military conflicts forcing major economies to “choose sides,“ leading to de-globalization and market fragmentation. Over the last 5 years, this trend caused Walmart's imports from China to fall as much as 20%. Although other economies like Thailand, India or Vietnam could replace these imports, these new deals still carry increased risks of hurting the net margin.