Can Walmart Stock Make A Comeback In 2016?

• Walmart stock has put up one of its worst performances in recent history.
•  Walmart continues to be plagued by a number of issues including swelling costs and poor e-commerce growth.
•  Against this backdrop, can Walmart stock make a comeback in 2016?
  Can Walmart Stock Make A Comeback in 2016

Walmart (NYSE:WMT) has endured a torrid year in 2015, with its shares finishing the year 29.6% down, its worst performance in more than 10 years. To be fair the entire retail sector languished during the year with the SPDR S&P Retail ETF (XRT) finishing 2015 almost 10% down. Walmart stock has cratered badly, and many investors now hold the opinion that Walmart is grossly undervalued.

Walmart stock price chart by amigobulls.com

Morningstar recently rated Walmart stock as its top defensive pick in the consumer sector saying the shares are grossly undervalued:

“At 14.5 times trough earnings in fiscal 2017 (calendar 2016), Wal-Mart shares have a lot of pessimism baked in, presenting an opportunity for investors with a three- to five-year time horizon to generate solid risk-adjusted returns,”

Morningstar is just one of the latest Wall Street analysts that have been waxing bullish about Walmart shares. Nomura recently picked Walmart as its favorite retail play in 2016, on the basis of low oil/gas prices.

But how justified are these sentiments about Walmart? More importantly, can Walmart stock make a comeback in 2016?

Walmart’s Troubles
The growing sentiment amongst investment circles that Walmart stock is grossly undervalued is only partly true. Walmart shares sport a forward PE ratio of 13.1, which is not that far-removed from the company’s 5-year average of 14.6 or the 10-year median of 15.3. When viewed against the industry average PE ratio of 19.4, however, Walmart shares do look undervalued. But let’s face it: with nearly $500B in annual sales, Walmart is the largest retail chain not only in the U.S, but the world as well. This is a rather stodgy retail company with no clear growth runways. This behemoth is showing serious signs of anemic growth at both its top and bottom lines with no real prospects for solid improvement. If the market is to award Walmart a higher multiple, the company will have to demonstrate that it can still grow despite its massive size.

Walmart is currently facing numerous challenges, many of which appear to be long-term. First off, Walmart’s sticky tax evasion issues still hang over the company liken a dark cloud. Extensive investigations by United Food & Commercial Workers International Union revealed in mid-2015 that the company has been hiding $76B in a huge secretive web consisting of 78 subsidiaries located in 15 disparate tax havens where the giant retailer has no retail presence. These secret operations have helped the company save as much as $3.5B in tax bills over the past six years. This is not the first time Walmart is facing tax evasion allegations. About a decade ago, the company ran into trouble with the authorities for using a real estate investment trust that used to pay rent to itself and in the process incur huge tax deductions. Walmart accounts for ~2% of all corporate income tax paid to the U.S. treasury every year, and it’s hardly surprising that its tax evasion allegations are being so closely watched.

But that is just part of Walmart’s woes. Walmart’s bottom line has been under a lot of pressure lately due to confluence of factors including heavy investments in e-commerce, higher wages for its workers, and FX headwinds due to a strong dollar. During the latest quarter, Walmart’s earnings per share fell 13.9% to $0.99, continuing a string of earnings declines that extend back several quarters. Full year earnings are expected to fall 6% to $4.78/share. The retailer sounded a warning that it expects flat net sales growth for fiscal 2015 and 3%-4% over the next three years. Furthermore, the company said that it expects earnings during fiscal 2016 to decline 6%-12% primarily due to the company hiking its hourly wage from $9 to $10 which will inflate its wage bill by $1.5B.

Walmart has resorted to using rather desperate measures to cut costs. The company has been asking vendors to scale back on advertising, and is reportedly planning to start charging its 10,000 suppliers a fee for storing their merchandise in Walmart warehouses. This is a radical shift from the way the company has always done business, and could threaten its ability to maintain its tag as a low-price retailer.

e-Commerce Recovery Could Provide A Turning Point
Not much seems to be going right at Walmart, and all that investor pessimism appears justified. The company’s e-commerce business is not faring any better either: Walmart’s e-commerce sales growth fell to just 10% during the last quarter from 30% two years ago. Even though Walmart’s online sales account for just ~2.5% of revenue, the segment holds the best promise of growth for the company.

Walmart still owns the second-largest e-commerce business after market leader Amazon (NASDAQ:AMZN). But the company trails Amazon by a wide margin: during the first three quarters of 2015, Walmart realized online sales of $13.2 billion vs. $71.8 billion by Amazon.

After many years of under-investing in its online business, Walmart has lately been pouring billions of dollars into the business. The company has in particular been working fervently to improve its online delivery services, including opening a series of giant fulfillment centers to make it easier and faster to meet customer orders.

Walmart has also worked on its dynamic pricing model to help it compete better with Amazon. Dynamic pricing is a pricing concept introduced and widely used by Amazon. This online pricing model has been shown to work better than Walmart’s traditional everyday low prices. Recent studies by e-commerce firm 360pi found that Walmart’s online prices have been closely tracking Amazon’s with just a 5% difference, the best record for any online retailer.

Walmart’s mobile app is now the third most popular in the retail world.

Investor Takeaway

Investors should remember that even though Walmart shares appear cheap, the stock’s PE ratio has touched a low of 10.6 over the last 10 years implying the shares could still fall further. I, however, believe that Walmart shares can recover if the company’s e-commerce growth can return to its previous levels. Current indications are that the company’s e-commerce operations are on the right track. Walmart shares can start making a comeback during the second half of 2016 if its e-commerce business shows marked improvement. Investors should watch how the company’s e-commerce business fares over the coming two quarters before loading on the shares for the long haul.