Walmart: A Dividend Aristocrat Facing Growth Challenges

Founded in 1945, Walmart (WMT) is the world’s largest retailer with more than $500 billion in annual revenue and over 11,000 stores. About half of Walmart’s stores are located in international markets, where the company has had a presence since 1991. However, the majority of Walmart’s sales and profits are derived from the company’s U.S. stores (64% of revenue) and Sam’s Club (12%).

Walmart sells just about everything. From groceries (56% of U.S. sales) to health & wellness products (11%) to general merchandise (32%), the company’s strategy is to be the low-price leader in every product category.

In addition to its brick-and-mortar operations, Walmart's website offers millions of products that can be shipped or picked up at one of the retailer's thousands of stores.

E-commerce sales account for about 5% of the company’s total revenue but will continue growing in importance as Walmart invests less in new store openings and more in its digital operations, supply chain, and logistics.

With 46 consecutive years of dividend increases behind it, Walmart is a dividend aristocrat and is slated to become a dividend king in 2024.

Business Analysis
Guided by its founding mantra of "everyday low prices", Walmart has risen to become the number one retailer in the world.

The intense focus on low cost is made possible by Walmart's substantial size, economies of scale, and the nation's largest distribution and logistics network.

The company has spent decades and tens of billions of dollars building, adapting, and perfecting its huge network of stores. Today, 90% of the U.S. population lives within 10 miles of one of Walmart's 6,000 stores, served by a logistics network that...

  • sources products from more than 100,000 suppliers in over 100 countries 
  • has over 150 distribution centers which average over 1 million square feet
  • runs a fleet of more than 6,100 trucks, 61,000 trailers, and 7,800 drivers 
  • has each distribution center support 90-plus stores within a 150-mile radius

In a highly competitive, low-margin industry like retail, few rivals have the financial resources or patience to attempt to replicate the company's extensive supply chain.

Over the past 70 years, Walmart has proven itself capable of adapting to grow its business. In the 1980s, for instance, Walmart concluded that it had largely saturated the U.S. market with its traditional discount centers.

In response, the company launched Hypermarkets and then Supercenters, massive stores averaging 180,00 square feet in size that combine groceries and general merchandise under one roof. Walmart is now America's largest grocer with about double the market share of its nearest competitor, Kroger (KR).

With the introduction of the first Sam's Club in 1983, Walmart copied the success of Costco's warehouse business model to charge members an annual fee for the right to buy large quantities of goods at bulk discounts. Sam's Club now has nearly 600 stores across the world and generates 12% of the company's sales.

In the 1990s, Walmart began expanding overseas and experimenting with Neighborhood Markets, smaller stores designed to miniaturize a Supercenter in urban markets.

Each step of the way, Walmart further dominated the retail scene while bolstering its competitive advantages.

That said, the company will need to adapt once again as e-commerce retailers like Amazon (AMZN) encroach on Walmart's territory. In fact, starting around 2014 Walmart suffered through several years of declining same-store sales, revenue, and earnings.

Since then, Walmart has aggressively pursued acquisitions and internal investments to improve its online presence, remodel its existing stores, and recreate Amazon's focus on convenience.

For example, by leveraging and continuing to invest in its nationwide distribution network, Walmart is able to offer free two-day shipping on online orders and can even ship next-day to most parts of the U.S.

At least in part due to these efforts, Walmart has returned to steady same-store sales growth, albeit at a low single-digit pace. While there is still plenty of work to be done, Walmart appears to be making progress on its plans to prove that it can, once again, adapt to a fast-changing retail world and compete with e-commerce behemoth Amazon.

However, there are several risks that could suppress Walmart's pace of earnings and dividend growth for the foreseeable future.

Key Risks
Consumer retail is a cutthroat industry marked by little customer loyalty. Competition is intense and characterized by a race to the bottom on price.

Where Walmart was once the clear leader of low prices on almost anything imaginable, Amazon has quickly gained market share by offering an even greater number of products and services delivered in an ever-more convenient and affordable manner.

Competition isn't abating, either. Walmart's CEO Doug McMillion himself said that he expects the pace of change in e-commerce to accelerate in the coming years.

In other words, Walmart may find itself confronting and responding to a never-ending barrage of disruption in the retail industry. One year it's two-day shipping, the next it's two-hour delivery of fresh produce, all table stakes for competing in modern retail.

Even if Walmart succeeds in adapting to change, their success may not translate into profits. Since 2015 the company's operating margin has steadily eroded from 6% to 4%, indicating that growth in online sales isn't necessarily translating to higher earnings.

As it has in the past, Walmart may be able to cut costs via its efficient supply chain to improve profit margins. Automation could, in the future, reduce costs further. But in a highly competitive retail world, most savings end up being passed on to consumers.

Moreover, rising labor costs may further pressure Walmart's profitability. Target and Amazon have announced minimum wage increases in an effort to create a happier workforce with lower turnover, creating growing competition in the labor market as well.  

Income investors should expect Walmart's slow pace of dividend growth to continue for the foreseeable future as the firm works to adapt its business and prove that its omnichannel investments can drive profitable growth.

Finally, while Walmart is working to replicate its U.S. success in China and India, these regions have different consumer cultures and well-established incumbents who've spent decades optimizing their own product mixes and distribution networks. Walmart lacks the same dominant logistics infrastructure in these markets that it enjoys in the U.S.

In the end, whether Walmart tries to grow domestically or abroad, the company faces intense competition from well-capitalized and nimble rivals.

Closing Thoughts on Walmart
Walmart has done an admirable job adapting to changing industry conditions over the years. That includes an impressive entrance into e-commerce that should help the world's largest retailer remain relevant for a long time.

In addition, the company's high mix of defensive grocery products and dedication to rewarding dividend investors with 46 consecutive years of dividend increases make it a fairly low-risk dividend stock.

That said, Walmart's recent success in adapting to e-commerce has so far failed to result in consistently strong earnings growth. Meanwhile, online sales have compressed the company's margins while demanding substantial capital investments, and their long-term profitability remains uncertain.

Given the company's accelerating pace of e-commerce investments, Walmart seems likely to keep raising its dividend at a modest pace of 2% per year for the foreseeable future.

Overall, Walmart is an interesting dividend aristocrat to watch because of its scale and defensive qualities, but the many challenges the company faces shouldn't be ignored. For now, Walmart seems likely to remain a low-growth cash cow that should be considered only when its dividend yield is at a historically high level.

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