DLTR - Walmart: India Growth Unlikely To Be Sustainable

2023-05-31 22:53:32 ET

Summary

• Walmart's Q1 performance showed impressive growth in e-commerce sales and Sam's Club memberships but faces challenges in the Indian market due to competition and regulations.
• WMT has been successful in attracting higher-income consumers, which can potentially boost future margins.
• Walmart's stock is currently fairly valued, and it is recommended to wait for a more favorable price point before investing.

Investment Thesis

Walmart (WMT) had a decent first quarter, which was further boosted by the management raising their guidance for FY24. In this article, however, I argue why the growth seen in its international markets, especially in India, while impressive, is unlikely to be sustainable. Furthermore, I also argue why it's best to avoid this company, in the medium term, from a valuation perspective.

Q1 Highlights

Walmart had a decent first quarter in my opinion. Revenues came in at $152.30 billion, which represents a year-over-year increase of 8.56%, beating estimates by $4.31 billion. Adjusted EPS came in at $1.47, which represents a year-over-year increase of 13.1%, beating estimates by $0.15. The adjusted EPS figure does have a caveat though, as it excludes the effects of a $0.85 loss incurred as a result of net losses on equity and other investments.

Management also noted that there was a considerable shift in the sales mix as consumers focused more on lower-margin categories such as groceries and health & wellness, and less on higher-margin categories such as general merchandise. This resulted in a decline in operating margins. Despite this, management did raise their FY24 guidance, with net sales now expected to increase 3.5% and adjusted EPS expected to be in the range between $6.10 and $6.20.

Growth in E-Commerce and Memberships is Impressive

One of the major highlights from WMT’s Q1 performance was the impressive growth witnessed in both e-commerce sales and Sam’s Club memberships. Net sales through e-Commerce grew 26% year-over-year, driven by the pickup and delivery channel. The segment also witnessed double-digit growth in operating income.

WMT’s online marketplace in the U.S. witnessed a 40% year-over-year growth in seller count, which was one of the primary drivers behind the growth in e-Commerce segment, along with strong increase in conversion rates.

According to PYMNTS , the e-Commerce share of retail spending was up 22% in the first quarter of this year, a higher figure compared to the 15% growth reported by Census Bureau. In the long-run, revenue from eCommerce is expected to grow at a CAGR of 11.57% to $1.56 trillion by 2027. This bodes well for WMT, especially given how the company has been investing and growing its e-Commerce channel.

Growth was also seen in the memberships, especially in Sam’s Club. Q1 saw yet another record growth in Sam’s club memberships as the division witnessed the largest quarterly membership sign-up on record. Membership penetration also hit an all-time high during the quarter. Furthermore, the growth seen in e-Commerce is also boosting the company’s Walmart Plus membership program, as evidenced by the fact that 50% of the Walmart Plus members were coming via the online pickup and delivery channel. Given that management is seeing members spending more than non-members, the record growth in membership bodes well for the company’s future sales.

China Could Be a Growth Story but Strong Headwinds Await in India

Q1 also saw strong growth in WMT’s international markets, especially in China and India. Both Walmart China and Flipkart, the Indian e-commerce platform acquired by Walmart, saw double-digit sales growth during the quarter. The double-digit growth in China occurred despite the e-commerce penetration being only at 40% and despite the Chinese economy yet to reach pre-pandemic levels. With six more Sam Clubs opening this year, China should continue to be a growth spot for WMT, especially when the economy does reach pre-Covid levels.

India, however, will be a more challenging market for Walmart in the long term despite the impressive progress the company has made there since acquiring Flipkart and taking a majority stake in PhonePe. This is primarily down to the intense competition the company is likely to face from homegrown player Reliance Industries, owned by Asia’s richest man, Mukesh Ambani.

According to Alliance Bernstein , the Indian e-commerce market is expected to grow from $24 billion in 2018 to $133 billion by 2025, and represents a $100 billion incremental opportunity given that there are only three major players in the market (Flipkart, Reliance Retail (retail arm of Reliance Industries), and Amazon). The same report, however, goes on to say that Reliance Retail is likely to gain the majority of the market share given that it has the “most disruptive playbook,” thanks to its integrated approach to consumers, something that Flipkart doesn’t have.

Furthermore, Indian regulations prevent non-Indian e-commerce firms from owning more than 25% stake in a seller on their platforms. Once again, this gives Reliance an upper hand over WMT, since the former can deploy the inventory model, thereby giving it more control over inventory, pricing, and customer experience. WMT, on the contrary, can only deploy a marketplace model. Therefore, while WMT’s Flipkart is likely to grow in the coming years, it’s more likely to be capped as a result of the dominance of Reliance Retail and the unfavourable regulatory environment.

Attracting Higher Income Consumers Bodes Well for Future Margins

During the first quarter, WMT was also successful at attracting higher income consumers . The progress made by the company in its e-commerce operations together with the current macroeconomic climate was responsible for a larger proportion of this category being attracted to Walmart stores. This trend, which started during the second quarter of last year, has continued in the past few quarters.

Furthermore, the higher income consumers are not only shopping for groceries but also general merchandise, and they are also buying higher-priced items across both categories. While there is a slowdown in the purchase of big-ticket items, the company nevertheless continues to benefit from the higher-income consumers’ appetite for high-priced essentials and their contribution towards driving e-commerce growth.

Valuation

Sources: Refinitiv, WMT’s Q1 Earnings Report , and Author’s Calculations

The company expects adjusted FY24 EPS to come in between $6.10 and $6.20. I have assumed the projected FY24 EPS to be $6.15, the midpoint of the management’s guidance. The company currently trades at a forward P/E of 22.7x, which in my opinion is not unreasonably expensive (Costco for instance, according to Refinitiv, trades at 33.3x and Dollar Tree trades at 18x forward P/E). Even historically, WMT has been trading at 22.4x. Therefore, I have assumed a forward P/E of 22.7x in my calculations.

WMT trades at a forward PEG ratio of 4.25x, which implies an earnings growth rate of 5.34%. This, therefore, results in a projected FY25 EPS of $6.48.

At a forward P/E of 22.7x and adjusted EPS of $6.48, this would result in a price target of $147, which is around the levels where the company is currently trading. And when the macro uncertainties that continue to plague the U.S. are factored in, in my opinion, it is better to wait for a more favourable price point before initiating a position in the stock.

Concluding Thoughts

WMT had a much better quarter than many expected and also relative to some of its peers. The company is seeing tremendous growth in its e-commerce channel and has also been attracting higher-income consumers, which can only boost margins further. While progress in international markets has been impressive, especially in China and India, the company is likely to face considerable headwinds in the latter. Furthermore, the current macro uncertainties remain unfavourable and from a valuation perspective, the stock is fairly valued. As such, it’s better to take a raincheck on this retail giant.

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