Once financial engineering fails, all bets are off
Wal-Mart had a bad-hair day. Its shares plunged $6.71, the largest single-day cliff-dive in its illustrious history. They ended the day down 10%, at $60.02, a number first kissed in 2001. Shares are 34% off their peak in January. So it wasn’t just today.
But Wal-Mart didn’t do anything that special at its annual investor meeting today. It announced big “capital investments,” (we’ll get to the quotation marks in a moment), a crummy outlook, and a huge share buyback program. All of which it has done many times before. Only this time, the outlook is even worse, but the promised share buybacks are even larger.
Wal-Mart proffered its strategies on how it would try to boost revenue growth in an environment where its primary customers – the 80% that got trampled by the Fed’s policies – are struggling to make ends meet. A problem Wal-Mart has had for years.
The news release hints at these new initiatives, spells out costs, and forecasts the resulting earnings debacle.
Wal-Mart will goose “capital investments” by $11 billion in Fiscal 2017, on top of the $12.4 billion it’s spending on “capital investments” in fiscal 2016. This will maul earnings per share. In 2017, they’re expected to drop 6% to 12%, when the analyst community had forecast an increase of 4%. But 2019 is back in the rosy scenario of earnings growth.
These capital investments aren’t computers, buildings, or new shelves. They’re largely “investments in wages and training,” which isn’t a capital investment at all, but an ordinary expense.
“Seventy-five percent of next year’s investment will be related to people,” CEO Doug McMillon clarified. That’s why they’ll hit earnings right away. A true capital investment would be an asset that is depreciated over time, with little earnings impact upfront.
So sales in fiscal 2016 would be flat, which Wal-Mart blamed on “currency exchange fluctuations.” Would that be the strong dollar? But sales were also flat for the prior three fiscal years when the dollar was weak. Don’t lose hope, however. In the future, starting in fiscal 2017, sales would edge up 3% to 4%. To accomplish this, management is now desperately praying for inflation.
The most chilling words in the news release? “These are exciting times in retail given the pace and magnitude of change.”
Then there was the announcement of a $20-billion share buyback program. $8.6 billion remaining from the $15 billion buyback program authorized in 2013 would be retired. That $15-billion program was on top of $36 billion in buyback programs over the preceding four years. Buybacks is what Wal-Mart does best.
At the time – over two years ago – Bloomberg put it this way:
The world’s largest retailer is grappling with myriad challenges. Wal-Mart is trying to goose slowing sales gains in the U.S. as such rivals as Amazon.com Inc. and the dollar stores lure its customers. Overseas, the company is struggling to ignite growth in China and other emerging markets even as it probes allegations of bribery in Mexico and possible violations of the Foreign Corrupt Practices Act.
Wal-Mart is also contending with increasingly restive labor groups clamoring for better working conditions. Protesters from OUR Walmart, a union-backed organization of employees, descended on Bentonville this week.
Hence the recent and future pay increases that have somehow become “capital investments.” Bloomberg also noted at the time:
The buybacks have pushed the founding Walton family’s stake in the company past 50%, giving Wal-Mart the right under New York Stock Exchange rules to have a minority of independent directors on the board. The company has said it has no plans to take advantage of the rules.
So Wal-Mart has faced the same difficulties in this Fed-designed economy for years. Wal-Mart’s primary customers, the lower 80% on the income scale, have practically no savings, and every month is a battle to make ends meet. It is hard to increase sales when your customers are this strung-out – not just in the US but in its markets around the globe
And that’s what has happened. Sales and profits have languished for years. Worse than “languished”: profits actually fell 3.7% over the past three fiscal years. Disappointment after disappointment.
But thanks to these giant buyback programs and the megatons of Wall Street hype associated with them, and thanks to QE, shares have climbed 75% from 2011 to January 2015. No growth no problem! Share buybacks overcome all sins.
But since January, the math has stopped working. Today, Wal-Mart projected a worse earnings debacle than before but offered an even bigger share buyback program than before. Share buybacks pumped up the shares back then successfully. But they haven’t recently. And they didn’t today. Something changed.
Share buybacks, usually funded with borrowed money, have been among the most powerful forces behind the multi-year stock market rally. It has been the most successful method of financial engineering. It worked practically every time. It didn’t matter that revenues and earnings were going to heck as long as the share buybacks were big enough.
If that scheme has lost its appeal, and if Wal-Mart is a harbinger of how financial engineering fails to boost share prices of revenue-and-earnings challenged companies – which includes much of the S&P 500 – then more stocks, one after the other or perhaps together, will fall off their precariously swaying perch. In this era, once financial engineering fails to prop up stock prices, all bets are off.
So now, junk-rated, money-losing, revenue-challenged Dell tries to pull off its own giant piece of financial engineering. Read… Peak Desperation
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
I would like to better understand how buying back stock helps stock value. Any help here?
WS readers correct me if I am wrong, but the basic premise here is that the company has 1000 shares outstanding at a price of 10 bucks each. So, say the price declines to 9 bucks a share because business sucks. When the shares decline in value, the company can buy them off the market to prop up the price. This is classic supply/demand. Let’s say the company buys up 100 shares, and pushes the price back to 10 bucks a share as they do so. As a share holder, who didn’t sell, this seems “equal”, but there are less shares on the market(also called “float” in terms of total stock outstanding or in another sense “liquidity” which is how much stock trades in a period of time). The 100 shares now owed by the company are often called “treasury stock” and if they are “retired” they go *poof* into the dustbin.
For years now, companies have been GORGING on stock buy backs at very low interest rates and this is a KEY reason stock prices are still so damn high. The economy hasn’t been good, but buybacks propped it all up. This is actually patently bad, but what the hell, prices are up, so no one cares until they go down for realz (like the OP is suggesting happened to WalMart).
To be clear, how much money can you borrow (to buy back stock of your company) if interest rates are zero percent and your paycheck/bonus depends on stock price? Capiche?
This game works … until it doesn’t … and when it starts not working …
Regards,
Cooter
All you need to know:
http://www.investopedia.com/articles/02/041702.asp
They use share buyback to remove some of the outstanding shares and the new, lesser amount of shares in the company when compared to the assets of the company usually trend higher
Allan,
Many stock performance measures are based on the number of stock shares. If a company buys back shares then it reduces the number of outstanding shares of stock so as the denominator (shares) decreases the ratio (in this case earnings per share) increase.
So the shares held by the company are not used in the calculation of EPS? Only the share s held outside of the company?
Allan you’ve raised a very interesting question. Let me see if I can help with it. The operative term here is “dilution”. Company treasurers usually have un-issued shares in their safe to be used when executives exercise their stock options. Those shares may or may not be included in the calculation of earnings per share. If they are included, the earnings are described as diluted.
If they are not counted in the EPS calculation then the earnings are not diluted. That can produce problems, because if after the books close the executives exercise a lot of options, the increase in the share count it can cause the EPS to suddenly drop. That doesn’t make shareholders happy.
So whether the internal shares are counted or not is at the option/discretion of the company?
Yes
This is an interesting piece on buybacks: http://www.theatlantic.com/politics/archive/2015/02/kill-stock-buyback-to-save-the-american-economy/385259/
Wal-Mart will wind up like K-Mart soon enough
Sam Walton, if he was still alive, would be 97 this year. If he was, WalMart would NOT be the mess it is … it would be a great and admirable company. WalMart has suffered what most family businesses suffer; the founders descendants (a.k.a lazy, greedy entitled s**theads).
Or, as the Chinese have been said to put it; family wealth does not span three generations.
I spent many years as a youth in NorthWest Arkansas and Sam was a very old school, but also honorable, businessman. As a billionare he drove an old Chevy pickup truck and was a ruthless bookkeeper at any of his stores. He would fly into parking lots with a small plane for surprise inspections to question “minor” expenses that stuck out in expense reports. The man loved to save money which is how the WalMart empire got built in the first place.
He died in 1992. NAFTA passed in 1994. I am not sure he would have been on board as he was fairly patriotic.
Just my two cents and second hand info based on where I grew up. I never met the man.
All that said, I only step in WalMart these days when I have no options left.
Regards,
Cooter
As a second-generation owner of a business that directly competes with Wal-Mart in the food sector, I agree 100% with the assertion:
“WalMart has suffered what most family businesses suffer; the founders descendants (a.k.a lazy, greedy entitled s**theads).”
We need a 95% wealth tax for everything above 2.5M in inheritance and 100% for everything above 10M.
This could be tied to COLA for SS beneficiaries to prevent “interested citizens” from “lobbying” to “reform” the law. Just a thought.
Sounds like what Karl Marx wanted.
Reminds me of back in the day when K-Mart was king and Wal-Mart was coming on the scene. All of Wal-Mart’s ads were about “Made in America” and basically saying K-Mart was selling cheap Chinese crap and was unpatriotic.
Fast forward a few years later and K-Mart’s lost all market share to Wal-Mart and then all of a sudden, Wal-Mart is king of low prices and you can hardly find anything “Made in America” at Wal-Mart.
Classic bait and switch!
COSTCO (COST) a Wally-World competitor is doing better. Better stores, better help, better pay, better prices. So, who “needs” Walmart?
Went to my 1st Costco in Rochester MN a couple of years ago. Buttonholed customers in the parking lot on their opinion of Costco. Then went home and bought 100 shares at $83 WMT was about $70 at the time.
Wife said ok to Costco ‘hell no’ on buying wall mart. She does moat of the shopping, trust her judgement…
I agree. Costco is super dope. (I’m a millenial, so I have to talk this way, even at job interviews, haha).
They have quality brands and actually really good food. For some reason, nothing is very expensive there unlike other supermarkets I’ve been to. I’m going there tomorrow, its actually really fun to shop there. My family bought some of their favorite clothes there: hats, pants, jackets, socks — all good quality and everything at most 12-20 dollars.
One reason their prices are good is because the max they’ll markup a product is 18%. Also, their in store brand, Kirkland, has a really wide range of products are are almost always cheaper than the name brands and greater in volume. Quality, at least in my experience, is comparable to the name brands.
14-18% margin, no advertising, customers paying $50/yr membership fee for the right to walk in the door.
In my semi-rural county (pop<150,000), the well-heeled openly admit that they'll pay the annual membership fee to "not have to shop with the riff-raff."
Walmart provides what I consider to be an unpleasant shopping experience. That’s bad news for them, since I’m a solvent retiree who actually can afford to shop there.
In the Palm Springs, CA area where I now live, the local Walmart store is often dirty. Shopping carts are often unavailable at the store entrance, meaning one must walk back to the parking lot to grab a cart and wheel it into the store. Walmart has stopped carrying many of the products I used to buy, and the store is frequently out of stock on common household supplies – like Windex cleaner and Dawn dish liquid. Walmart has also been aggressively raising prices – common household products are probably 30% higher since the first of the year. Lastly, the people who used to be greeters have been turned into ‘receipt checkers’ which is annoying to customers. Walmart is not a membership store like Costco or Sam’s Club.
For all of the above reasons, I’ve pretty much stopped shopping at Walmart. I just wait until one of the grocery stores has a sale on the items I want to buy.
If Walmart won’t fix the issues I wrote about, raising the pay of their employees isn’t going to help. I expect that rising pay will cause stores to further cut employee hours, meaning that their service and stocking issues will become worse, not better.
They have become disfunctional due to insane growth and the disinterest of high level brass in actual day-to-day operations of stores (they just care about ratios, metrics, their bonuses, and so on). This leads to cost cutting in labor to goose numbers, but also leads to lower quality employees if care is not taken to keep quality up. The quality aspect has long fallen to the way side, in the quest for lower prices at all costs, and they are now reaping the harvest.
To hell with them.
I once wasted a month buying a handgun from WalMart, who told me straight up they could order it (I offered cash/credit card up front), then spent weeks jerking off, before finally telling me they couldn’t. And I was dealing with managers. It was crazy. I made almost ten trips over the several weeks, patiently trying to get it sorted out – for nothing.
I live in a small town in AK and these kinds of “i-want-this” purchases are more difficult than one might imagine (at cost effective rates), so I stuck with it … but the lesson for me was clear.
I only buy flat out commodity products at WalMart now, when the price is good and I can’t get it at a store I like (i.e. want to give my business).
Regards,
Cooter
We also live in Palm Springs & will never go back to Walmart !
Help me understand one thing.
Back when I lived in the US, Walmart was considered a shopping outlet for low-income families. This doesn’t appear to have changed and it means their customers are those most afflicted by that creeping debasement not showing up in BLS statistics. For someone living paycheck to paycheck (I used to be one of them so I know what I am talking about), the price of butter, pork, apples and cabbages is far more important than the official CPI.
So how can Walmart expect that a flareup in official CPI figures would benefit their sales? A CPI increase of 3% would probably mean an increase in the cost of living (the true bottom line) of 7% if not 8% as the prices of energy and food always respond to inflationary pressures far more than cellphones and TV’s.
This means Walmart customers would have far less money to spend on those mountains of Made in China consumer goods Walmart has been importing so enthusiastically and upon which their good fortune was built.
If the nominal price of what you are selling goes up 7% but sales of that item decrease by a similar amount as your customers cannot afford to buy as much as they used to, where’s the gain? Walmart is not Louis Vuitton or BMW.
The old Walmart in our city is always jammed. It’s on the bus line, and the food stampers and scooter people have easy access. It is a disgusting store, and the parking lot is no place to be after dark. It is the city’s number one crime center, with more police calls than anyplace else. It has been written that crime in a five mile radius of a new Walmart goes up 70% over time.
Well, they built a new Walmart, ten minutes north, in an upscale part of town., that is not on the bus line. It’s been months now, and the place has more workers inside than customers. With the most efficient self-checkout I’ve ever seen, the fat women working the registers are just standing around. This kind of needless growth can’t help but hurt Walmart’s bottom line.
So now it looks like America is facing the bursting of the retail bubble, along with the bursting of the shale energy bubble and a tech bubble 3.0. Might be some scary times coming for bankers and hedge fund lenders.
Is Walmart going to the wall?
I agree that Walmart are shabby stores with shabby customers. I read the arrest reports from the local sheriff’s office and almost every shoplifter is arrested at Walmart. It reminds me of those ‘Black Friday’ riots that happen outside of Walmarts. One wonders what it is that Walmart sells that is worth waiting outside at 4:00AM for and then fighting over to buy?
I note that Target stores are cleaner, brighter and have less repulsive people in them. Maybe that has something to do with Target pushing their own credit card with a 5% discount for purchases made with it. A customer able to qualify for a credit card is going to be a higher quality customer.
Vegas could have written my comment. His: “Walmart provides what I consider to be an unpleasant shopping experience. That’s bad news for them, since I’m a solvent retiree who actually can afford to shop there.”…said it all. I actually used to like K-Mart and shopping there, But when I go into a WalMart I feel a bit of shame and embarrassment, so I seldom do. (2X per year, maybe…and that will be for something I can’t find anywhere else).
Costco was mentioned. Their prices are not always the best so don’t expect you are saving $ just because the boxes are big. However, shopping there is usually a pleasant experience provided you are not there on a peak moment (holiday Saturday). Their products are higher quality and if they do have a dud they take it back and refund with absolutely no questions. Their employees are unionized and make a decent wage. Their employees smile and work hard….seem focused.
WalMart is heading for eventual collapse, imho. It may take awhile, but their entire store mimics their customer base, and that is definitely NOT success. I buy paint brushes and work gloves at The Dollar store. Whenever I go there I see very poor people and retirees buying groceries and pastic crap. They go there instead of WalMart. If the store branches out into clothes they will take even more market share. I just hope they still sell paint brushes.
regards
“Seventy-five percent of next year’s investment will be related to people,”
Really?
Allow me to translate the c-suite-speak into proper english:
‘Layoffs’
I agree, ERG.
Layoffs coming to Walmart. Our town of 125K has 2 Walmarts, one is a superstore. Half the town lives on subsidies and is on the edge. Dollar Stores have expanded here. Like Petunia, I won’t shop at Walmart, We have a good Target, and all the rest. Drive 40 minute to Costco. The US can’t have it both ways. You can’t gut your middle class and still have revenues. The top 1% don’t support anyone. The shutdowns are coming and will devastate local and state government revenues. They will not be able to keep their people and the pensions will be impossible. You can’t have it both ways. I used to worry about fascism, and yes we have some, but the elites can’t afford that either. The German fascism was supported by US investment, like Ford, and the Bush family. There won’t be any investors to prop up the US govt. Life will get a lot better for us without them.
No one touched on the most offensive part of the Walmart experience which is political. Many of us that don’t shop, don’t because ever sale is subsidized by local taxpayers. Most of their employees qualify for food stamps, and welfare, while working for them. The local taxpayers are actually subsidizing all those sales. This is why I never shop there and never will.
Correction, sorry:
Many of us that don’t shop there, don’t because every sale is subsidized by local taxpayers.
Even more frustrating is the fact that minimum wage workers are so pressed they end up depending on local food banks. Our contributions to worthy charities are thus subsidizing those businesses that are fighting to keep wages low.
Great point! Charity can be an enabler. I’m for personal charity, not institutional. Gave up on United Way, etc, 15 years ago.