Growth Stalls are deadly for valuation, and both Mcdonald’s and Apple are in one.
August, 2014 I wrote about McDonald’s Growth Stall. The company had 7 straight months of revenue declines, and leadership was predicting the trend would continue. Using data from several thousand companies across more than 3 decades, companies in a Growth Stall are unable to maintain a mere 2% growth rate 93% of the time. 55% fall into a consistent revenue decline of more than 2%. 20% drop into a negative 6%/year revenue slide. 69% of Growth Stalled companies will lose at least half their market capitalization in just a few years. 95% will lose more than 25% of their market value. So it is a long-term concern when any company hits a Growth Stall.
A new CEO was hired, and he implemented several changes. He implemented all-day breakfast, and multiple new promotions. He also closed 700 stores in 2015, and 500 in 2016. And he announced the company would move its headquarters from suburban Oakbrook to downtown Chicago, IL. While doing something, none of these actions addressed the fundamental problem of customers switching to competitive options that meet modern consumer food trends far better than McDonald’s.
McDonald’s stock languished around $94/share from 8/2014 through 8/2015 – but then broke out to $112 in 2 months on investor hopes for a turnaround. At the time I warned investors not to follow the herd, because there was nothing to indicate that trends had changed – and McDonald’s still had not altered its business in any meaningful way to address the new market realities.
Yet, hopes remained high and the stock peaked at $130 in May, 2016. But since then, the lack of incremental revenue growth has become obvious again. Customers are switching from lunch food to breakfast food, and often switching to lower priced items – but these are almost wholly existing customers. Not new, incremental customers. Thus, the company trumpets small gains in revenue per store (recall, the number of stores were cut) but the growth is less than the predicted 2%. The only incremental growth is in China and Russia, 2 markets known for unpredictable leadership. The stock has now fallen back to $120.
Given that the realization is growing as to the McDonald’s inability to fundamentally change its business competitively, the prognosis is not good that a turnaround will really happen. Instead, the common pattern emerges of investors hoping that the Growth Stall was a “blip,” and will be easily reversed. They think the business is fundamentally sound, and a little management “tweaking” will fix everything. Small changes will lead to the classic hockey-stick forecast of higher future growth. So the stock pops up on short-term news, only to fall back when reality sets in that the long-term doesn’t look so good.
Unfortunately, Apple’s Q3 2016 results (reported yesterday) clearly show the company is now in its own Growth Stall. Revenues were down 11% vs. last year (YOY or year-over-year,) and EPS (earnings per share) were down 23% YOY. 2 consecutive quarters of either defines a Growth Stall, and Apple hit both. Further evidence of a Growth Stall exists in iPhone unit sales declining 15% YOY, iPad unit sales off 9% YOY, Mac unit sales down 11% YOY and “other products” revenue down 16% YOY.
This was not unanticipated. Apple started communicating growth concerns in January, causing its stock to tank. And in April, revealing Q2 results, the company not only verified its first down quarter, but predicted Q3 would be soft. From its peak in May, 2015 of $132 to its low in May, 2016 of $90, Apple’s valuation fell a whopping 32%! One could say it met the valuation prediction of a Growth Stall already – and incredibly quickly!
But now analysts are ready to say “the worst is behind it” for Apple investors. They are cheering results that beat expectations, even though they are clearly very poor compared to last year. Analysts are hoping that a new, lower baseline is being set for investors that only look backward 52 weeks, and the stock price will move up on additional company share repurchases, a successful iPhone 7 launch, higher sales in emerging countries like India, and more app revenue as the installed base grows – all leading to a higher P/E (price/earnings) multiple. The stock improved 7% on the latest news.
So far, Apple still has not addressed its big problem. What will be the next product or solution that will replace “core” iPhone and iPad revenues? Increasingly competitors are making smartphones far cheaper that are “good enough,” especially in markets like China. And iPhone/iPad product improvements are no longer as powerful as before, causing new product releases to be less exciting. And products like Apple Watch, Apple Pay, Apple TV and IBeacon are not “moving the needle” on revenues nearly enough. And while experienced companies like HBO, Netflix and Amazon grow their expanding content creation, Apple has said it is growing its original content offerings by buying the exclusive rights to “Carpool Karaoke“ – yet this is very small compared to the revenue growth needs created by slowing “core” products.
Like McDonald’s stock, Apple’s stock is likely to move upward short-term. Investor hopes are hard to kill. Long-term investors will hold their stock, waiting to see if something good emerges. Traders will buy, based upon beating analyst expectations or technical analysis of price movements. Or just belief that the P/E will expand closer to tech industry norms. But long-term, unless the fundamental need for new products that fulfill customer trends – as the iPad, iPhone and iPod did for mobile – it is unclear how Apple’s valuation grows.
My last column focused on growth, and the risks inherent in a Growth stall. As I mentioned then, Apple will enter a Growth Stall if its revenue declines year-over-year in the current quarter. This forecasts Apple has only a 7% probability of consistently growing just 2%/year in the future.
This usually happens when a company falls into Defend & Extend (D&E) management. D&E management is when the bulk of management attention, and resources, flow into protecting the “core” business by seeking ways to use sustaining innovations (rather than disruptive innovations) to defend current customers and extend into new markets. Unfortunately, this rarely leads to high growth rates, and more often leads to compressed margins as growth stalls. Instead of working on breakout performance products, efforts are focused on ways to make new versions of old products that are marginally better, faster or cheaper.
Using the D&E lens, we can identify what looks like a sea change in Apple’s strategy.
For example, Apple’s CEO has trumpeted the company’s installed base of 1B iPhones, and stated they will be a future money maker. He bragged about the 20% growth in “services,” which are iPhone users taking advantage of Apple Music, iCloud storage, Apps and iTunes. This shows management’s desire to extend sales to its “installed base” with sustaining software innovations. Unfortunately, this 20% growth was a whopping $1.2B last quarter, which was 2.4% of revenues. Not nearly enough to make up for the decline in “core” iPhone, iPad or Mac sales of approximately $9.5B.
Apple has also been talking a lot about selling in China and India. Unfortunately, plans for selling in India were at least delayed, if not thwarted, by a decision on the part of India’s regulators to not allow Apple to sell low cost refurbished iPhones in the country. Fearing this was a cheap way to dispose of e-waste they are pushing Apple to develop a low-cost new iPhone for their market. Either tactic, selling the refurbished products or creating a cheaper version, are efforts at extending the “core” product sales at lower margins, in an effort to defend the historical iPhone business. Neither creates a superior product with new features, functions or benefits – but rather sustains traditional product sales.
Of even greater note was last week’s announcement that Apple inked a partnership with SAP to develop uses for iPhones and iPads built on the SAP ERP (Enterprise Resource Planning) platform. This announcement revealed that SAP would ask developers on its platform to program in Swift in order to support iOS devices, rather than having a PC-first mentality.
This announcement builds on last year’s similar announcement with IBM. Now 2 very large enterprise players are building applications on iOS devices. This extends the iPhone, a product long thought of as great for consumers, deeply into enterprise sales. A market long dominated by Microsoft. With these partnerships Apple is growing its developer community, while circumventing Microsoft’s long-held domain, promoting sales to companies as well as individuals.
And Apple has shown a willingness to help grow this market by introducing the iPhone 6se which is smaller and cheaper in order to obtain more traction with corporate buyers and corporate employees who have been iPhone resistant. This is a classic market extension intended to sustain sales with more applications while making no significant improvements in the “core” product itself.
And Apple’s CEO has said he intends to make more acquisitions – which will surely be done to shore up weaknesses in existing products and extend into new markets. Although Apple has over $200M of cash it can use for acquisitions, unfortunately this tactic can be a very difficult way to actually find new growth. Each would be targeted at some sort of market extension, but like Beats the impact can be hard to find.
Remember, after all revenue gains and losses were summed, Apple’s revenue fell $7.6B last quarter. Let’s look at some favorite analyst acquisition targets to explain:
- Box could be a great acquisition to help bring more enterprise developers to Apple. Box is widely used by enterprises today, and would help grow where iCloud is weak. IBM has already partnered with Box, and is working on applications in areas like financial services. Box is valued at $1.45B, so easily affordable. But it also has only $300M of annual revenue. Clearly Apple would have to unleash an enormous development program to have Box make any meaningful impact in a company with over $500B of revenue. Something akin of Instagram’s growth for Facebook would be required. But where Instagram made Facebook a pic (versus words) site, it is unclear what major change Box would bring to Apple’s product lines.
- Fitbit is considered a good buy in order to put some glamour and growth onto iWatch. Of course, iWatch already had first year sales that exceeded iPhone sales in its first year. But Apple is now so big that all numbers have to be much bigger in order to make any difference. With a valuation of $3.7B Apple could easily afford FitBit. But FitBit has only $1.9B revenue. Given that they are different technologies, it is unclear how FitBit drives iWatch growth in any meaningful way – even if Apple converted 100% of Fitbit users to the iWatch. There would need to be a “killer app” in development at FitBit that would drive $10B-$20B additional annual revenue very quickly for it to have any meaningful impact on Apple.
- GoPro is seen as a way to kick up Apple’s photography capabilities in order to make the iPhone more valuable – or perhaps developing product extensions to drive greater revenue. At a $1.45B valuation, again easily affordable. But with only $1.6B revenue there’s just not much oomph to the Apple top line. Even maximum Apple Store distribution would probably not make an enormous impact. It would take finding some new markets in industry (enterprise) to build on things like IoT to make this a growth engine – but nobody has said GoPro or Apple have any innovations in that direction. And when Amazon tried to build on fancy photography capability with its FirePhone the product was a flop.
- Tesla is seen as the savior for the Apple Car – even though nobody really knows what the latter is supposed to be. Never mind the actual business proposition, some just think Elon Musk is the perfect replacement for the late Steve Jobs. After all the excitement for its products, Tesla is valued at only $28.4B, so again easily affordable by Apple. And the thinking is that Apple would have plenty of cash to invest in much faster growth — although Apple doesn’t invest in manufacturing and has been the king of outsourcing when it comes to actually making its products. But unfortunately, Tesla has only $4B revenue – so even a rapid doubling of Tesla shipments would yield a mere 1.6% increase in Apple’s revenues.
- In a spree, Apple could buy all 4 companies! Current market value is $35B, so even including a market premium $55B-$60B should bring in the lot. There would still be plenty of cash in the bank for growth. But, realize this would add only $8B of annual revenue to the current run rate – barely 25% of what was needed to cover the gap last quarter – and less than 2% incremental growth to the new lower run rate (that magic growth percentage to pull out of a Growth Stall mentioned earlier in this column.)
Such acquisitions would also be problematic because all have P/E (price/earnings) ratios far higher than Apple’s 10.4. FitBit is 24, GoPro is 43, and both Box and Tesla are infinite because they lose money. So all would have a negative impact on earnings per share, which theoretically should lower Apple’s P/E even more.
Acquisitions get the blood pumping for investment bankers and media folks alike – but, truthfully, it is very hard to see an acquisition path that solves Apple’s revenue problem.
All of Apple’s efforts big efforts today are around sustaining innovations to defend & extend current products. No longer do we hear about gee whiz innovations, nor do we hear about growth in market changing products like iBeacons or ApplePay. Today’s discussions are how to rejuvenate sales of products that are several versions old. This may work. Sales may recover via growth in India, or a big pick-up in enterprise as people leave their PCs behind. It could happen, and Apple could avoid its Growth Stall.
But investors have the right to be concerned. Apple can grow by defending and extending the iPhone market only so long. This strategy will certainly affect future margins as prices, on average, decline. In short, investors need to know what will be Apple’s next “big thing,” and when it is likely to emerge. It will take something quite significant for Apple to maintain it’s revenue, and profit, growth.
The good news is that Apple does sell for a lowly P/E of 10 today. That is incredibly low for a company as profitable as Apple, with such a large installed base and so many market extensions – even if its growth has stalled. Even if Apple is caught in the Innovator’s Dilemma (i.e. Clayton Christensen) and shifting its strategy to defending and extending, it is very lowly valued. So the stock could continue to perform well. It just may never reach the P/E of 15 or 20 that is common for its industry peers, and investors envisioned 2 or 3 years ago. Unless there is some new, disruptive innovation in the pipeline not yet revealed to investors.
Growth fixes a multitude of sins. If you grow revenues enough (you don’t even need profits, as Amazon has proven) investors will look past a lot of things. With revenue growth high enough, companies can offer employees free meals and massages. Executives and senior managers can fly around in private jets. Companies can build colossal buildings as testaments to their brand, or pay to have thier names on public buildings. R&D budgets can soar, and product launches can fail. Acquisitions are made with no concerns for price. Bonuses can be huge. All is accepted if revenues grow enough.
Just look at Facebook. Today Facebook announced today that for the quarter ended March, 2016 revenues jumped to $5.4B from $3.5B a year ago. Net income tripled to $1.5B from $500M. And the company is basically making all its revenue – 82% – from 1 product, mobile ads. In the last few years Facebook paid enormous premiums to buy WhatsApp and Instagram – but who cares when revenues grow this fast.
Anticipating good news, Facebook’s stock was up a touch today. But once the news came out, after-hours traders pumped the stock to over $118//share, a new all time high. That’s a price/earnings (p/e) multiple of something like 84. With growth like that Facebook’s leadership can do anything it wants.
But, when revenues slide it can become a veritable poop puddle. As Apple found out.
Rumors had swirled that Apple was going to say sales were down. And the stock had struggled to make gains from lows earlier in 2016. When the company’s CEO announced Tuesday that sales were down 13% versus a year ago the stock cratered after-hours, and opened this morning down 10%. Breaking a streak of 51 straight quarters of revenue growth (since 2003) really sent investors fleeing. From trading around $105/share the last 4 days, Apple closed today at ~$97. $40B of equity value was wiped out in 1 day, and the stock trades at a p/e multiple of 10.
The new iPhone 6se outsold projections, iPads beat expectations. First year Apple Watch sales exceeded first year iPhone sales. Mac sales remain much stronger than any other PC manufacturer. Apple iBeacons and Apple Pay continue their march as major technologies in the IoT (Internet of Things) market. And Apple TV keeps growing. There are about 13M users of Apple’s iMusic. There are 1.5M apps on the iTunes store. And the installed base keeps the iTunes store growing. Share buybacks will grow, and the dividend was increased yet again. But, none of that mattered when people heard sales growth had stopped. Now many investors don’t think Apple’s leadership can do anything right.
Yet, that was just one quarter. Many companies bounce back from a bad quarter. There is no statistical evidence that one bad quarter is predictive of the next. But we do know that if sales decline versus a year ago for 2 consecutive quarters that is a Growth Stall. And companies that hit a Growth Stall rarely (93% of the time) find a consistent growth path ever again. Regardless of the explanations, Growth Stalls are remarkable predictors of companies that are developing a gap between their offerings, and the marketplace.
Which leads us to Chipotle. Chipotle announced that same store sales fell almost 30% in Q1, 2016. That was after a 15% decline in Q4, 2015. And profits turned to losses for the quarter. That is a growth stall. Chipotle shares were $750/share back in early October. Now they are $417 – a drop of over 44%.
Customer illnesses have pointed to a company that grew fast, but apparently didn’t have its act together for safe sourcing of local ingredients, and safe food handling by employees. What seemed like a tactical problem has plagued the company, as more customers became ill in March.
Whether that is all that’s wrong at Chipotle is less clear, however. There is a lot more competition in the fast casual segment than 2 years ago when Chipotle seemed unable to do anything wrong. And although the company stresses healthy food, the calorie count on most portions would add pounds to anyone other than an athlete or construction worker – not exactly in line with current trends toward dieting. What frequently looks like a single problem when a company’s sales dip often turns out to have multiple origins, and regaining growth is nearly always a lot more difficult than leadership expects.
Growth is magical. It allows companies to invest in new products and services, and buoy’s a stock’s value enhancing acquisition ability. It allows for experimentation into new markets, and discovering other growth avenues. But lack of growth is a vital predictor of future performance. Companies without growth find themselves cost cutting and taking actions which often cause valuations to decline.
Right now Facebook is in a wonderful position. Apple has investors rightly concerned. Will next quarter signal a return to growth, or a Growth Stall? And Chipotle has investors heading for the exits, as there is now ample reason to question whether the company will recover its luster of yore.
United Continental Holdings is the most recent public company to come under attack by hedge funds. Last week Altimeter Capital and PAR Capital announced they were using their combined 7.1% ownership of United to propose a slate of 6 new directors to the company’s board. As is common in such hedge fund moves, they expressed strongly their lack of confidence in United’s board, and pointed out multiple years of underperformance.
United’s leadership is certainly in a tough place. The airline consistently ranks near the bottom in customer satisfaction, and on-time performance. It has struggled for years with labor strife, and the mechanics union just rejected their proposed contract – again. The flight attendant’s union has been in mediation for months. And few companies have had more consistently bad public relations, as customers have loudly complained about how they are treated – including one fellow making a music and speaking career out of how he was abused by United personnel for months after they destroyed his guitar.
But is changing the directors going to change the company? Or is it just changing the guest list for an haute couture affair? Should customers, employees, suppliers and investors expect things to really improve, or is this a selection between the devil and the deep blue sea?
Much was made of the fact that one of the proposed new directors is the former CEO of Continental, Gordon Bethune, who was very willing to speak out loudly and negatively regarding United’s current board. But Mr. Bethune is 74 years old. Today most companies have mandatory director retirement somewhere between age 68 and 72. Retired since 2004, is Mr. Bethune really in step with the needs of airline customers today? Does he really have a current understanding of how the best performing airlines keep customers happy while making money?
And, don’t forget, Mr. Bethune hand picked Mr. Jeff Smisek to replace him at Continental. Mr. Smisek was the fellow who took over Mr. Bethune’s board seat in 2004 after being appointed President and COO when Mr. Bethune retired. Smisek became CEO in 2010, and CEO of United Continental after the merger, and led the ongoing deterioration in United’s performance as well as declining employee moral. And then there’s that pesky problem of Mr. Smisek bribing government officials to improve United’s gate situation in Newark, NJ which caused him to be fired by the current board. Is it coincidental that this attack on the Board did not happen for years, but happens now that there is a new CEO – who happens to be recently recovering from a heart replacement?
Although Mr. Bethune has commented that the new board would be one that understands the airline industry, the slate does not reflect this. Mr. Gerstner is head of Altimiter and by all accounts appears to be a finance expert. That was the background Ed Lampert brought to Sears, another big Chicago company, when he took over that board. And that has not worked out too well at all for any constituents – including investors.
One can give great kudos to the hedge funds for proposing a very diverse slate. Half the proposed directors are either female or of color. And, other than Mr. Bethune, the slate is pretty young – with 2 proposed directors under age 50. Congratulations on achieving diversification! But a deeper look can cause us to wonder exactly what these directors bring to the challenges, and what they are likely to want to change at United.
Rodney O’Neal was the former CEO of Delphi Automotive. A lifelong automotive manager and executive, he graduated from the General Motors Institute and spent his career at GM before going to the parts unit GM had created in 1997 as a Vice President. Many may have forgotten that Delphi famously filed for bankruptcy in 2005, and proceeded to close over half its U.S. plants, then close or sell almost all of the other half in 2006. Mr. O’Neal became CEO in 2007, after which the company closed its plants in Spain despite having signed a commitment letter not to do so. He was CEO in 2008 when the company sued its shareholders. And in 2009 when the company sold its core assets to private investors, then dumped assets into the bankrupt GM, cancelled the stock and renamed the old Delphi DPH Holdings. Cutting, selling and reorganizing seem to be his dominant executive experience.
Barney Harford is a young, talented tech executive. He headed Orbitz, where Mr. Gerstner was on the board. Orbitz was originally created as the Travelocity and Expedia killer by the major airlines. Unfortunately, it never did too well and Mr. Harford actually changed the company direction from primarily selling airline tickets to selling hotel rooms.
It is always good to see more women proposed for board positions. However, Ms. Brenda Yester Baty is an executive with Lennar, a very large Florida-based home builder. And Ms. Tina Stark leads Sherpa Foundry which has a 1 page web site saying “Sherpa Foundry builds
bridges between the world’s leading Corporations and the Innovation Economy.” What that means leaves a lot of room for one’s imagination, and precious little specifics. What either of these people have to do with creating a major turnaround in the operations of United is unclear.
There is no doubt that United is ripe for change. Replacing the CEO was clearly a step in the right direction – if a bit late. But one has to wonder if the new directors are there to make some specific change? If so, what kind of change? Despite the rough rhetoric, there has been no proclamation of what the new director slate would actually do differently. No discussion of a change in strategy – or any changes in any operating characteristics. Just vague statements about better governance.
Historically most activists take firm aim at cutting costs. And this is probably why the 2 largest unions have already denounced the new slate, and put their full support behind the existing board of directors. After so many years of ill-will between management and labor at United, one would wonder why these unions would not welcome change. Unless they fear the new board will be mostly focused on cost-cutting, and further attempts at downsizing and pay/benefits reductions.
Investors will most likely get to vote on this decision. Keep existing board members, or throw them out in favor of a new slate? One would like to see United’s reputation, and operations, improve dramatically. But is changing out 6 directors the answer? Or are investors facing a vote that has them selecting between 2 less than optimal options? It would be good if there was less rhetoric, and more focus on actual proposals for change.
Walmart announced quarterly financial results last week, and they were not good. Sales were down $500million vs the previous year, and management lowered forecasts for 2016. And profits were down almost 8% vs. the previous year. The stock dropped, and pundits went negative on the company.
But if we take an historical look, despite how well WalMart’s value has done between 2011 and 2014, there are ample reasons to forecast a very difficult future. Sailors use small bits of cloth tied to their sails in order to get early readings on the wind. These small bits, called telltales, give early signs that good sailors use to plan their navigation forward. If we look closely at events at WalMart we can see telltales of problems destined to emerge for the retailing giant:
1 – In March, 2008 WalMart sued a brain damaged employee. The employee was brain damaged by a truck accident. WalMart’s insurance paid out $470,000 in health care cost. The employee’s family sued the trucking company, at their own expense, and won a $417,000 verdict for lost future wages, pain and suffering and future care needs. Then, WalMart decided it would sue the employee to recover the health care costs it had previously paid. As remarkable as this seems, it is a great telltale. It demonstrates a company so focused on finding ways to cut costs, and so insensitive to its employees and the plight of its customers that it loses all common sense. Not to mention the questionable ethics of this action, it at the very least demonstrates blatant disregard for the PR impact of its actions. It shows a company where management feels it is unquestionable, and a believe its brand is untouchable.
2 – In March, 2010 AdAge ran a column about WalMart being “stuck in the middle” and effectively becoming the competitive “bulls-eye” of retailing. After years of focusing on its success formula, “dollar store” competition was starting to undermine it on cost and price at the low end, while better merchandise and store experience boxed WalMart from higher end competitors – that often weren’t any more expensive. This was the telltale sign of a retailer that had focused on beating up its suppliers for years, cutting them out of almost all margin, without thinking about how it might need to change its business model to grow as competitors chopped up its traditional marketplace.
3 – In October, 2010 Fortune ran an article profiling then-CEO Mike Duke. It described an executive absolutely obsessive about operational minutia. Banana pricing, underwear inventory, cereal displays – there was no detail too small for the CEO. Another telltale of a company single-mindedly focused on execution, to the point of ignoring market shifts created by changing consumer tastes, improvements at competitors and the rapid growth of on-line retailing. There was no strategic thinking happening at WalMart, as executives believed there would never be a need to change the strategy.
4 – In April, 2012 WalMart found itself mired in a scandal regarding bribing Mexican government officials in its effort to grow sales. WalMart had never been able to convert its success formula into a growing business in any international market, but Mexico was supposedly its breakout. However, we learned the company had been paying bribes to obtain store sites and hold back local competitors. A telltale of a company where pressure to keep defending and extending the old business was so great that very highly placed executives do the unethical, and quite likely the illegal, to make the company look like it is performing better.
5 – In July, 2014 a WalMart truck driver hits a car seriously injuring comedian Tracy Morgan and killing his friend. While it could be taken as a single incident, the truth was that the driver had been driving excessive hours and excessive miles, not complying with government mandated rest periods, in order to meet WalMart distribution needs. This telltale showed how the company was stressed all the way down into the heralded distribution environment to push, push, push a bit harder to do more with less in order to find extra margin opportunities. What once was successful was showing stress at the seams, and in this case it led to a fatal accident by an employee.
6 – In January, 2015 we discovered traditional brick-and-mortar retail sales fell 1% from the previous year. The move to on-line shopping was clearly a force. People were buying more on-line, and less in stores. This telltale bode very poorly for all traditional retailers, and it would be clear that as the biggest WalMart was sure to face serious problems.
7 – In July, 2015 Amazon’s market value exceeds WalMart’s. Despite being quite a bit smaller, Amazon’s position as the on-line retail leader has investors forecasting tremendous growth. Even though WalMart’s value was not declining, its key competition was clearly being forecast to grow impressively. The telltale implies that at least some, if not a lot, of that growth was going to eventually come directly from the world’s largest traditional retailer.
8 – In January, 2016 we learn that traditional retail store sales declined in the 2015 holiday season from 2014. This was the second consecutive year, and confirmed the previous year’s numbers were the start of a trend. Even more damning was the revelation that Black Friday sales had declined in 2013, 2014 and 2015 strongly confirming the trend away from Black Friday store shopping toward Cyber Monday e-commerce. A wicked telltale for the world’s largest store system.
9 – In January, 2016 we learned that WalMart is reacting to lower sales by closing 269 stores. No matter what lipstick one would hope to place on this pig, this telltale is an admission that the retail marketplace is shifting on-line and taking a toll on same-store sales.
10 – We now know WalMart is in a Growth Stall. A Growth Stall occurs any time a company has two consecutive quarters of lower sales versus the previous year (or two consecutive declining back-to-back quarters.) In the 3rd quarter of 2015 Walmart sales were $117.41B vs. same quarter in 2014 $119.00B – a decline of $1.6B. Last quarter WalMart sales were $129.67B vs. year ago same quarter sales of $131.56B – a decline of $1.9B. While these differences may seem small, and there are plenty of explanations using currency valuations, store changes, etc., the fact remains that this is a telltale of a company that is already in a declining sales trend. And according to The Conference Board companies that hit a Growth Stall only maintain a mere 2% growth rate 7% of the time – the likelihood of having a lower growth rate is 93%. And 95% of stalled companies lose 25% of their market value, while 69% of companies lose over half their value.
WalMart is huge. And its valuation has actually gone up since the Great Recession began. It’s valuation also rose from 2011- 2014 as Amazon exploded in size. But the telltale signs are of a company very likely on the way downhill.
Verizon tipped its hand that it would be interested to buy Yahoo back in December. In the last few days this possibility drew more attention as Verizon’s CFO confirmed interest on CNBC, and Bloomberg reported that AOL’s CEO Tim Armstrong is investigating a potential acquisition. There are some very good reasons this deal makes sense:
First, this acquisition has the opportunity to make Verizon distinctive. Think about all those ads you see for mobile phone service. Pretty much alike. All of them trying to say that their service is better than competitors, in a world where customers don’t see any real difference. 3G, 4G – pretty soon it feels like they’ll be talking about 10G – but users mostly don’t care. The service is usually good enough, and all competitors seem the same.
So, that leads to the second element they advertise – price. How many different price programs can anyone invent? And how many phone or tablet give-aways. What is clear is that the competition is about price. And that means the product has become generic. And when products are generic, and price is the #1 discussion, it leads to low margins and lousy investor returns.
But a Yahoo acquisition would make Verizon differentiated. Verizon could offer its own unique programming, at a meaningful level, and make it available only on their network. And this could offer price advantages. Like with Go90 streaming, Verizon customers could have free downloads of Verizon content, while having to pay data fees for downloads from other sites like YouTube, Facebook, Vine, Instagram, Amazon Prime, etc. The Verizon customer could have a unique experience, and this could allow Verizon to move away from generic selling and potentially capture higher margins as a differentiated competitor.
Second, Yahoo will never be a lead competitor and has more value as a supporting player. Yahoo has lost its lead in every major competitive market, and it will never catch up. Google is #1 in search, and always will be. Google is #1 in video, with Facebook #2, and Yahoo will never catch either. Ad sales are now dominated by adwords and social media ads – and Yahoo is increasingly an afterthought. Yahoo’s relevance in digital advertising is at risk, and as a weak competitor it could easily disappear.
But, Verizon doesn’t need the #1 player to put together a bundled solution where the #2 is a big improvement from nothing. By integrating Yahoo services and capabilities into its unique platform Verizon could take something that will never be #1 and make it important as part of a new bundle to users and advertisers. As supporting technology and products Yahoo is worth quite a bit more to Verizon than it will ever be as an independent competitor to investors – who likely cannot keep up the investment rates necessary to keep Yahoo alive.
Third, Yahoo is incredibly cheap. For about a year Yahoo investors have put no value on the independent Yahoo. The company’s value has been only its stake in Alibaba. So investors inherently have said they would take nothing for the traditional “core” Yahoo assets.
Additionally, Yahoo investors are stuck trying to capture the Alibaba value currently locked-up in Yahoo. If they try to spin out or sell the stake then a $10-12Billion tax bill likely kicks in. By getting rid of Yahoo’s outdated business what’s left is “YaBaba” as a tracking stock on the NASDAQ for the Chinese Alibaba shares. Or, possibly Alibaba buys the remaining “YaBaba” shares, putting cash into the shareholder pockets — or giving them Alibaba shares which they may prefer. Etiher way, the tax bill is avoided and the Alibaba value is unlocked. And that is worth considerably more than Yahoo’s “core” business.
So it is highly unlikely a deal is made for free. But lacking another likely buyer Verizon is in a good position to buy these assets for a pretty low value. And that gives them the opportunity to turn those assets into something worth quite a lot more without the overhang of huge goodwill charges left over from buying an overpriced asset – as usually happens in tech.
Fourth, Yahoo finally gets rid of an ineffectual Board and leadership team. The company’s Board has been trying to find a successful leader since the day it hired Carol Bartz. A string of CEOs have been unable to define a competitive positioning that works for Yahoo, leading to the current lack of investor enthusiasm.
The current CEO Mayer and her team, after months of accomplishing nothing to improve Yahoo’s competitiveness and growth prospects, is now out of ideas. Management consulting firm McKinsey & Company has been brought in to engineer yet another turnaround effort. Last week we learned there will be more layoffs and business closings as Yahoo again cannot find any growth prospects. This was the turnaround that didn’t, and now additional value destruction is brought on by weak leadership.
Most of the time when leaders fail the company fails. Yahoo is interesting because there is a way to capture value from what is currently a failing situation. Due to dramatic value declines over the last few years, most long-term investors have thrown in the towel. Now the remaining owners are very short-term, oriented on capturing the most they can from the Alibaba holdings. They are happy to be rid of what the company once was. Additionally, there is a possible buyer who is uniquely positioned to actually take those second-tier assets and create value out of them, and has the resources to acquire the assets and make something of them. A real “win/win” is now possible.
Microsoft recently announced it was offering Windows 10 on xBox, thus unifying all its hardware products on a single operating system – PCs, mobile devices, gaming devices and 3D devices. This means that application developers can create solutions that can run on all devices, with extensions that can take advantage of inherent special capabilities of each device. Given the enormous base of PCs and xBox machines, plus sales of mobile devices, this is a great move that expands the Windows 10 platform.
Only it is probably too late to make much difference. PC sales continue falling – quickly. Q3 PC sales were down over 10% versus a year ago. Q2 saw an 11% decline vs year ago. The PC market has been steadily shrinking since 2012. In Q2 there were 68M PCs sold, and 66M iPhones. Hope springs eternal for a PC turnaround – but that would seem increasingly unrealistic.
The big market shift to mobile devices started back in 2007 when the iPhone began challenging Blackberry. By 2010 when the iPad launched, the shift was in full swing. And that’s when Microsoft’s current problems really began. Previous CEO Steve Ballmer went “all-in” on trying to defend and extend the PC platform with Windows 8 which began development in 2010. But by October, 2012 it was clear the design had so many trade-offs that it was destined to be an Edsel-like flop – a compromised product unable to please anyone.
By January, 2013 sales results were showing the abysmal failure of Windows 8 to slow the wholesale shift into mobile devices. Ballmer had played “bet the company” on Windows 8 and the returns were not good. It was the failure of Windows 8, and the ill-fated Surface tablet which became a notorious billion dollar write-off, that set the stage for the rapid demise of PCs.
And that demise is clear in the ecosystem. Microsoft has long depended on OEM manufacturers selling PCs as the driver of most sales. But now Lenovo, formerly the #1 PC manufacturer, is losing money – lots of money – putting its future in jeopardy. And Dell, one of the other top 3 manufacturers, recently pivoted from being a PC manufacturer into becoming a supplier of cloud storage by spending $67B to buy EMC. The other big PC manufacturer, HP, spun off its PC business so it could focus on non-PC growth markets.
And, worse, the entire OEM market is collapsing. For the largest 4 PC manufacturers sales last quarter were down 4.5%, while sales for the remaining smaller manufacturers dropped over 20%! With fewer and fewer sales, consolidation is wiping out many companies, and leaving those remaining in margin killing to-the-death competition.
Which means for Microsoft to grow it desperately needs Windows 10 to succeed on devices other than PCs. But here Microsoft struggles, because it long eschewed its “channel suppliers,” who create vertical market applications, as it relied on OEM box sales for revenue growth. Microsoft did little to spur app development, and rather wanted its developers to focus on installing standard PC units with minor tweaks to fit vertical needs.
Today Apple and Google have both built very large, profitable developer networks. Thus iOS offers 1.5M apps, and Google offers 1.6M. But Microsoft only has 500K apps largely because it entered the world of mobile too late, and without a commitment to success as it tried to defend and extend the PC. Worse, Microsoft has quietly delayed Project Astoria which was to offer tools for easily porting Android apps into the Windows 10 market.
Microsoft realized it needed more developers all the way back in 2013 when it began offering bonuses of $100,000 and more to developers who would write for Windows. But that had little success as developers were more keen to achieve long-term sales by building apps for all those iOS and Android devices now outselling PCs. Today the situation is only exacerbated.
By summer of 2014 it was clear that leadership in the developer world was clearly not Microsoft. Apple and IBM joined forces to build mobile enterprise apps on iOS, and eventually IBM shifted all its internal PCs from Windows to Macintosh. Lacking a strong installed base of Windows mobile devices, Microsoft was without the cavalry to mount a strong fight for building a developer community.
In January, 2015 Microsoft started its release of Windows 10 – the product to unify all devices in one O/S. But, largely, nobody cared. Windows 10 is lots better than Win8, it has a great virtual assistant called Cortana, and it now links all those Microsoft devices. But it is so incredibly late to market that there is little interest.
Although people keep talking about the huge installed base of PCs as some sort of valuable asset for Microsoft, it is clear that those are unlikely to be replaced by more PCs. And in other devices, Microsoft’s decisions made years ago to put all its investment into Windows 8 are now showing up in complete apathy for Windows 10 – and the new hybrid devices being launched.
AM Multigraphics and ABDick once had printing presses in every company in America, and much of the world. But when Xerox taught people how to “one click” print on a copier, the market for presses began to die. Many people thought the installed base would keep these press companies profitable forever. And it took 30 years for those machines to eventually disappear. But by 2000 both companies went bankrupt and the market disappeared.
Those who focus on Windows 10 and “universal windows apps” are correct in their assessment of product features, functions and benefits. But, it probably doesn’t matter. When Microsoft’s leadership missed the mobile market a decade ago it set the stage for a long-term demise. Now that Apple dominates the platform space with its phones and tablets, followed by a group of manufacturers selling Android devices, developers see that future sales rely on having apps for those products. And Windows 10 is not much more relevant than Blackberry.
I was born the 1950s. In my youth of the ’60s there was no doubt that the #1 sport in America was baseball. Almost every boy owned a bat, ball and glove and played baseball. When we went out for recess there was always a softball game somewhere on the playground.
Fathers told stories about how on the battlefields of WWII they would shout questions about baseball players and World Series statistics to each other to determine if the “other guy out there” was an American, or a German trying to sucker the Americans into the open. Baseball was so relevant every American was expected to know the details of players, games and series.
In that era, lots of baseball was played in the daytime, since the game and its parks preceded the era of great field lighting. Men regularly took off work to attend ball games, and it was considered fairly normal. People listened to baseball games on the radio at work.
And when the World Series came along, which was played around Labor Day, it was so beloved that people took TVs to work, hooked up makeshift antenna and watched the games. Even schools would set up a TV on the gymnasium stage and let the students watch the game — and some enterprising teachers would set up televisions in their classrooms and eschew teaching in favor of watching the series. It was even bigger than today’s Super Bowl, as pretty nearly everyone watched or listened to the World Series.
No longer. World Series viewership has been on a decline for at least 40 years. According to Wikipedia, World Series viewership was about 35million in the 1986-1991 timeframe. By 1998-2005 viewership was down to averaging 20million – a 40% decline. By 2008-2014 viewership had declined to 12million -another 40% decline – or a loss of 2/3 the viewership in 25 years.
By comparison, regular season games in the NFL 2014 season averaged about 18million viewers, and 114million people watched the February, 2015 Superbowl – almost 10 times World Series viewership. Even the women’s FIFA World Cup soccer match last July drew 25million American viewers – twice the World Series.
Are you aware the World Series is happening now? I will forgive you if you didn’t know. Marketwatch.com headlined “This Is the Most Exciting World Series No One is Watching.” From what was the #1 sporting event in America, and possibly the world, 50 years ago the World Series has become nearly irrelevant for most people.
Why? Trends have made the World Series, and really baseball, obsolete.
Big Trend #1 – We’re out of time. The pace of life is far, far different today than it was in 1965. Laconic weekday afternoons lounging in a ballpark to watch a game are a thing of the past. The fact that baseball has no time limit is probably its most negative feature. Games are a minimum of 9 innings, but in case of a tie they can last many, many more. Further, if it rains the game is delayed, which can extend the time an hour or more. Thirdly, you have no idea how long an inning may take. 15 minutes, or an hour, all depending on a raft of variables that are impossible to predict.
Game 1 of this current series is a great example of the problem this creates. The game lasted 14 innings. There was a rain delay in the middle of the game. Overall, it was a 5 hour 9 minute event. While this set a new record for a World Series game length, it clearly demonstrates the problem of a sporting event which has no clock.
The most popular games are highly clock bound. Football and basketball not only have limits on the game length, there is a clock limiting the time between plays (or shots.) Soccer is timebound, and there are no time outs. In these games that have greatly grown popularity people know how long a game will take, and that is important.
Big Trend #2 – Action. When was the last time you played a board game, like Monopoly or Life? Do you even own one any longer? Today games are action intensive. In the 1960s a pinball machine was the closest thing anyone had to an “action game.” Look at any game today, via console, computer or mobile device, and there is action. Even Tetris had action to it, and that is nothing compared to the modern video game. People now like action.
Then there is baseball. A “perfect game” – the ultimate for this sport – happens when 21 people bat, and every one walks back to the dugout without reaching base. Quite literally, nothing happens. A pitcher and catcher play catch, while the batters watch. The next most vaunted game is a “no-hitter,” in which people reach base via a walk or an error – but it again reflects a lack of action in that no batter achieved a hit. The third most celebrated game is a “shutout,” meaning one team literally ended the game with a score of Zero. Goose egg.
Baseball is a game of very little action. A really good game often ends with each team having less than 10 hits. It is rare for there to be more than 2 home runs in a game, and often there are games with no home runs at all. Heck, even in golf at least the athletes are hitting the ball 60+ times apiece!
We live in a world today where people run for fun. Or ride bicycles. Where people join gyms to work out on treadmills, rowers, stationary bikes and weight machines. Nobody did this kind of thing in the 1960s. People today are active, and being active is a sign of health, vitality and well-being. Sedentary behaviors are frowned upon. There is no sport with less action than baseball (except maybe darts.)
Big Trend #3 – Globalization. Despite Mr. Donald Trump’s xenophobic appeal, globalization is an unstoppable trend. Our businesses and our lives are increasingly global, as it is doubtful any American goes a day without touching a product or service delivered from an offshore source. And unlikely most Americans live any given day without talking to someone born in a foreign country, or entertaining them with news, information, sports or programming from outside the USA.
There is no sport which makes this clearer than soccer. Due to its global appeal, 715million people watched the final game of the 2006 World Cup (55 times the World Series.) 909million people watched the final 2010 World Cup game (71.5 times the current World Series.) [note: FIFA has not published numbers for the 2014 final game in Brazil, but it is surely going to exceed 1B viewers.]
American impact? There were almost as many Americans (11million) that watched the first round match between the USA and Ghana in the 2014 World Cup as are now watching a World Series Game. And the 2014 World Cup final game had 17.3M U.S. viewers – 34% more than are watching the World Series this year.
Basketball has some international appeal, as there are leagues across Europe and some in South America. And my son was shocked at how much people watched and played basketball on his trip to China. And we see globalization reflected in the players names now in the NBA.
We also see globalization reflected in the NHL, which has many players from outside the USA. And viewership is growing for NHL Stanley Cup games, although it is still only about half the World Series. But given the trajectories of viewership, and the fact that hockey is both a timed sport as well as action-filled, Stanley Cup watchers could exceed World Series watchers in just a few years.
Simply put, baseball has never extended strongly beyond the USA and Japan. Lacking competitive teams and viewers outside the USA, as well as limited non-USA player recruitment, this “most American of sports” is off one of the country’s (and planet’s) major trends.
In short, the world moved and baseball did not change with the times. People don’t live today like they did in the 1930s-1960s. Trends are vastly different. New sports that were better linked to major trends, and which adapted to trends (by adding things like shot clocks and play clocks, for example) have gained viewers, while baseball has declined.
Baseball didn’t do anything wrong. It just didn’t adapt. And competitors have moved in. Just like happens in business — which, of course, is the reason we have professional sports – you either adapt or you become obsolete.
The World Series was once the most relevant sporting event on the globe. No longer. And lacking some major changes in the game, its ability to ever grow again is seriously questionable.
This week McDonald’s and Microsoft both reported earnings that were higher than analysts expected. After these surprise announcements, the equities of both companies had big jumps. But, unfortunately, both companies are in a Growth Stall and unlikely to sustain higher valuations.
McDonald’s profits rose 23%. But revenues were down 5.3%. Leadership touted a higher same store sales number, but that is completely misleading.
McDonald’s leadership has undertaken a back to basics program. This has been used to eliminate menu items and close “underperforming stores.” With fewer stores, loyal customers were forced to eat in nearby stores – something not hard to do given the proliferation of McDonald’s sites. But some customers will go to competitors. By cutting stores and products from the menu McDonald’s may lower cost, but it also lowers the available revenue capacity. This means that stores open a year or longer could increase revenue, even though total revenues are going down.
Profits can go up for a raft of reasons having nothing to do with long-term growth and sustainability. Changing accounting for depreciation, inventory, real estate holdings, revenue recognition, new product launches, product cancellations, marketing investments — the list is endless. Further, charges in a previous quarter (or previous year) could have brought forward costs into an earlier report, making the comparative quarter look worse while making the current quarter look better.
Confusing? That’s why accounting changes are often called “financial machinations.” Lots of moving numbers around, but not necessarily indicating the direction of the business.
McDonald’s asked its “core” customers what they wanted, and based on their responses began offering all-day breakfast. Interpretation – because they can’t attract new customers, McDonald’s wants to obtain more revenue from existing customers by selling them more of an existing product; specifically breakfast items later in the day.
Sounds smart, but in reality McDonald’s is admitting it is not finding new ways to grow its customer base, or sales. The old products weren’t bringing in new customers, and new products weren’t either. As customer counts are declining, leadership is trying to pull more money out of its declining “core.” This can work short-term, but not long-term. Long-term growth requires expanding the sales base with new products and new customers.
Perhaps there is future value in spinning off McDonald’s real estate holdings in a REIT. At best this would be a one-time value improvement for investors, at the cost of another long-term revenue stream. (Sort of like Chicago selling all its future parking meter revenues for a one-time payment to bail out its bankrupt school system.) But if we look at the Sears Holdings REIT spin-off, which ostensibly was going to create enormous value for investors, we can see there were serious limits on the effectiveness of that tactic as well.
MIcrosoft also beat analysts quarterly earnings estimate. But it’s profits were up a mere 2%. And revenues declined 12% versus a year ago – proving its Growth Stall continues as well. Although leadership trumpeted an increase in cloud-based revenue, that was only an 8% improvement and obviously not enough to offset significant weakness in other markets:
It is a struggle to see the good news here. Office 365 revenues were up, but they are cannibalizing traditional Office revenues – and not fast enough to replace customers being lost to competitive products like Google OfficeSuite, etc.
Azure sales were up, but not fast enough to replace declining Windows sales. Further, Azure competes with Amazon AWS, which had remarkable results in the latest quarter. After adding 530 new features, AWS sales increased 15% vs. the previous quarter, and 78% versus the previous year. Margins also increased from 21.4% to 25% over the last year. Azure is in a growth market, but it faces very stiff competition from market leader Amazon.
We build our companies, jobs and lives around successful products and services. We want these providers to succeed because it makes our lives much easier. We don’t like to hear about large market leaders losing their strength, because it signals potentially difficult change. We want these companies to improve, and we will clutch at any sign of improvement.
As investors we behave similarly. We were told large companies have vast customer bases, strong asset bases, well known brands, high switching costs, deep pockets – all things Michael Porter told us in the 1980s created “moats” protecting the business, keeping it protected from market shifts that could hurt sales and profits. As investors we want to believe that even though the giant company may slip, it won’t fall. Time and size is on its side we choose to believe, so we should simply “hang on” and “ride it out.” In the future, the company will do better and value will rise.
As a result we see that Growth Stall companies show a common valuation pattern. After achieving high valuation, their equity value stagnates. Then, hopes for a turn-around and recovery to new growth is stimulated by a few pieces of good news and the value jumps again. Only after a few years the short-term tactics are used up and the underlying business weakness is fully exposed. Then value crumbles, frequently faster than remaining investors anticipated.
McDonald’s valuation rose from $62/share in 2008 to reach record $100/share highs in 2011. But valuation then stagnated. It is only this last jump that has caused it to reach new highs. But realize, this is on a smaller number of stores, fewer products and declining revenues. These are not factors justifying sustainable value improvement.
Microsoft traded around $25/share from March, 2003 through November, 2011 – 8.5 years. When the CEO was changed value jumped to $48/share by October, 2014. After dipping, now, a year later Microsoft stock is again reaching that previous valuation ($50/share). Microsoft is now valued where it was in December, 2002 (which is half its all-time high.)
The jump in value of McDonald’s and Microsoft happened on short-term news regarding beating analysts earnings expectations for one quarter. The underlying businesses, however, are still suffering declining revenue. They remain in Growth Stalls, and the odds are overwhelming that their values will decline, rather than continue increasing.
Wal-Mart market value took a huge drop on Wednesday. In fact, the worst valuation decline in its history. That decline continued on Thursday. Since the beginning of 2015 Wal-Mart has lost 1/3 of its value. That is an enormous ouch.
But, if you were surprised, you should not have been. The telltale signs that this was going to happen have been there for years. Like most stock market moves, this one just happened really fast. The “herd behavior” of investors means that most people don’t move until some event happens, and then everyone moves at once carrying out the implications of a sea change in thinking about a company’s future.
All the way back in October, 2010 I wrote about “The Wal-Mart Disease.” This is the disease of constantly focusing on improving your “core” business, while market shifts around you increasingly make that “core” less relevant, and less valuable. In the case of Wal-Mart I pointed out that an absolute maniacal focus on retail stores and low-cost operations, in an effort to be the low price retailer, was being made obsolete by on-line retailers who had costs that are a fraction of Wal-Mart’s expensive real estate and armies of employees.
At that time WMT was about $54/share. I recommended nobody own the stock.
In May, 2011 I reiterated this problem at Wal-Mart in a column that paralleled the retailer with software giant Microsoft, and pointed out that because of financial machinations not all earnings are equal. I continued to say that this disease would cripple Wal-Mart. Six months had passed, and the stock was about $55.
By February, 2012 I pointed out that the big reorganization at Wal-Mart was akin to re-arranging deck chairs on a sinking ship and said nobody should own the stock. It was up, however, trading at $61.
At the end of April, 2012 the Wal-Mart Mexican bribery scandal made the press, and I warned investors that this was a telltale sign of a company scrambling to make its numbers – and pushing the ethical (if not legal) envelope in trying to defend and extend its worn out success formula. The stock was $59.
Then in July, 2014 a lawsuit was filed after an overworked Wal-Mart truck driver ran into a car killing James McNair and seriously injuring comedian Tracy Morgan. Again, I pointed out that this was a telltale sign of an organization stretching to try and make money out of a business model that was losing its ability to sustain profits. Market shifts were making it ever harder to keep up with emerging on-line competitors, and accidents like this were visible cracks in the business model. But the stock was now $77. Most investors focused on short-term numbers rather than the telltale signs of distress.
In January, 2015 I pointed out that retail sales were actually down 1% for December, 2014. But Amazon.com had grown considerably. The telltale indication of a rotting traditional retail brick-and-mortar approach was showing itself clearly. Wal-Mart was hitting all time highs of around $87, but I reiterated my recommendation that investors escape the stock.
By July, 2015 we learned that the market cap of Amazon now exceeded that of Wal-Mart. Traditional retail struggles were apparent on several fronts, while on-line growth remained strong. Bigger was not better in the case of Wal-Mart vs. Amazon, because bigger blinded Wal-Mart to the absolute necessity for changing its business model. The stock had fallen back to $72.
Now Wal-Mart is back to $60/share. Where it was in January, 2012 and only 10% higher than when I first said to avoid the stock in 2010. Five years up, then down the roller coaster.
From October of 2010 through January, 2015 I looked dead wrong on Wal-Mart. And the folks who commented on my columns here at this journal and on my web site, or emailed me, were profuse in pointing out that my warnings seemed misguided. Wal-Mart was huge, it was strong and it would dominate was the feedback.
But I kept reiterating the point that long-term investors must look beyond short-term reported sales and earnings. Those numbers are subject to considerable manipulation by management. Further, short-term operating actions, like shorter hours, lower pay, reduced benefits, layoffs and gouging suppliers can all prop up short-term financials at the expense of recognizing the devaluation of the company’s long-term strategy.
Investors buy and hold. They hold until they see telltale signs of a company not adjusting to market shifts. Short-term traders will say you could have bought in 2010, or 2012, and held into 2014, and then jumped out and made a profit. But, who really can do that with forethought? Market timing is a fools game. The herd will always stay too long, then run out too late. Timers get trampled in the stampede more often than book gains.
In this week’s announcement Wal-Mart executives provided more telltale signs of their problems, and the fact that they don’t know how to fix them, and therefore won’t.
- Wal-Mart is going to spend $20B to buy back stock in order to prop up the price. This is the most obvious sign of a company that doesn’t know how to keep up its valuation by growing profits.
- Wal-Mart will spend $11B on sprucing up and opening stores. Really. The demand for retail space has been declining at 4-6%/year for a decade, and retail business growth is all on-line, yet Wal-Mart is still massively investing in its old “core” business.
- Wal-Mart will spend $1.1B on e-commerce. That is the proverbial “drop in the competitors bucket.” Amazon.com alone spent $8.9B in 2014 growing its on-line business.
- Wal-Mart admits profits will decline in the next year. It is planning for a growth stall. Yet, we know that statistically only 7% of companies that have a growth stall ever go on to maintain a consistent growth rate of a mere 2%. In other words, Wal-Mart is projecting the classic “hockey stick” forecast. And investors are to believe it?
The telltale signs of an obsolete business model have been present at Wal-Mart for years, and continue.
In 2003 Sears Holdings was $25/share. In 2004 Sears bought K-Mart, and the stock was $40. I said don’t go near it, as all the signs were bad and the merger was ill-conceived. Despite revenue declines, consistent losses, a revolving door at the executive offices and no sign of any plan to transform the battered, outdated retail giant against growing on-line competition investors believed in CEO Ed Lampert and bid the stock up to $77 in early 2011. (I consistently pointed out the telltale signs of trouble and recommended selling the stock.)
By the end of 2012 it was clear Sears was irrelevant to holiday shoppers, and the stock was trading again at $40. Now, SHLD is $25 – where it was 12 years ago when Mr. Lampert started his machinations. Again, only a market timer could have made money in this company. For long-term investors, the signs were all there that this was not a place to put your money if you want to have capital growth for retirement.
There will be plenty who will call Wal-Mart a “value” stock and recommend investors “buy on weakness.” But Wal-Mart is no value. It is becoming obsolete, irrelevant – increasingly looking like Sears. The likelihood of Wal-Mart falling to $20 (where it was at the beginning of 1998 before it made an 18 month run to $50 more than doubling its value) is far higher than ever trading anywhere near its 2015 highs.