Apparently taking lovability lessons from United Airlines (at least pre David Dao), ex-Uber boss Travis Kalanick and Pharma-bro Martin Shkreli, Wal-Mart (WMT) decided to lay down the hammer on suppliers telling them that they’ll be fined not only if deliveries are late but also if they’re early and that WMT will tolerate no disputes. Why is the company doing this? Will it help the mega merchant? What does this mean for investors?

The mega-retailer is getting tough with its suppliers. Will that be productive? (AP Photo/Jae C. Hong, File)

What’s Happening

According to Bloomberg writer Matthew Boyle, this program “labeled ‘On-Time, In-Full’ . . . aims to add $1 billion to improve revenue by improving product availability at stores (and) underscores the urgency Wal-Mart feels as it raises wags, cuts prices, and confronts a powerhouse rival in Amazon.com Inc. that’s poised to grow with tis planned purchase of Whole Foods Markets Inc.”

Citing a company sources, Boyle wrote that this On-Time-In-Full (OTIF) threshold was being raised from 90% to 95%. This can be a serious challenge since WMT acknowledged that none of its suppliers had been hitting the 95% target and that some big vendors, including even Procter & Gamble, had even been as low as 10%.

OTIF failures will be analyzed by a scoring system to assess fault; WMT versus the supplier and vendors can at least take comfort in the fact that they’ll escape the fines if WMT turns out to be at fault. There’s been no indication WMT would monetarily credit suppliers in cases of the latter, but in the spirit of fairness (to WMT), Boyle, quoting WMT, writes “If suppliers don’t agree with the fine, too bad: ‘Disputes will not be tolerated.’”

Obviously, this is bullish for consultants who can sell vendors on the idea they’ll be able to help them get into compliance, especially smaller vendors. As to what this might do for WMT, let’s look not to management spokespeople but to numbers.

Does It Make Sense?

The suggestion that a consequent improvement in product availability can add $1 billion to revenue sounds impressive if you say it fast enough (much thanks to Brooklyn Law School Professor Richard Farrell, for putting that delightful phrase into my head back in my youth). Slowing down, however, we should note that WMT’s trailing-12-month revenue was $487 billion. So the addition comes out to 0.21%, or if we round it off, it amounts to zero. In other words, we’re not talking about a genuine potential improvement in WMT’s top line. We’re talking about something that’s barely a decimal rounding error.

So let’s just acknowledge the obvious; the stated revenue goal is nonsense (and I’ll leave it readers to mentally edit in the more accurate but less respectably publishable word).

If it’s not revenues, then it has to be costs-profits, and if that’s the case, I have to assume we need to look at return on capital, the penultimate measure of this sort of thing. So let’s do that for WMT, and also for Amaon.com (AMZN) and for WMT’s brick-and-mortar peers.

Table 1 defines capital two ways, as total assets and as equity (return on equity is something that can be boosted by skillful use of debt). Also, besides showing the peer group as a whole, I subdivide the peer group by size; mega (market cap above $10 billion), large ($1 billion to $10 billion) and small (everything else big enough to be includable in a Russell 3000 type universe).

Table 1

Data from S&P Compustat via Portfolio123.com and reflects Compustat standardization protocols; ratios based on Portfolio123 protocols. TTM = trailing 12 months

WMT is already fine relative to its peers, especially the smaller peers where some pain is clearly being felt. WMT is also good relative to AMZN. But AMZN is gaining ground. It’s not the return comparison per se. It’s about the comparison in the trend. AMZN is racing forward and WMT seems to be more or less standing in place.

Table 2 echoes this in terms of margins, one of the key drivers of return on capital. Interpreting it is a bit tricky because the differences between gross and operating margin depend on how companies classify different kinds of expenses as being more directly linked to specifically sold products or more in the nature of general overhead. AMZN, as a different kind of business, classifies things differently. So in terms of gross margins, compare WMT only to its peers. But by the time we get down to operating margin, the differences have been washed away and all columns are comparable.

Table 2

Data from S&P Compustat via Portfolio123.com and reflects Compustat standardization protocols; ratios based on Portfolio123 protocols. TTM = trailing 12 months

Compared to peers, WMT is OK. It’s not necessarily top dog but that may well be an inevitable aspect of its stature as a discounter of non-exotic ordinary products. But once again, we see that AMZN, a lesser performer today, is making rapid movement. Remember all those crazy bears a few years ago who howled and bleated about how AMZN should be shorted because of its rotten margins? Well, Bezos finally did what the bulls always expected him to do; he flipped the switch toward profit and WMT may be every bit as nervous as anyone unfortunate enough not to have covered a failed short.

Margin alone isn’t everything. Low margins are fine if turnover (i.e. volume) is high enough.

Table 3 explores this metric.

AMZN Peer Averages All Mega Large Small Inventory Turn – TTM

Inventory Turn – 5Y Avg. Asset Turn – TTM Asset Turn – 5Y Avg.

Data from S&P Compustat via Portfolio123.com and reflects Compustat standardization protocols; ratios based on Portfolio123 protocols. TTM = trailing 12 months

Here again, WMT isn’t necessarily top dog among peers. But considering that differences are influenced by different business models and product lineups and considering that turnover must be stirred in with margin to get return on capital, it does not appear that WMT should lose sleep relative to peers.

But once again, we see AMZN standing out for its forward movement.

Let’s round out the picture by checking some financial strength highlights. 

Table 4

Data from S&P Compustat via Portfolio123.com and reflects Compustat standardization protocols; ratios based on Portfolio123 protocols. TTM = trailing 12 months

Because the cost of debt has been and still is so shockingly low and because there is no single correct way to organize a capital structure, we can’t hyper-analyze differences (even something like liquidity can be deemed excessive in some cases). All we look for on a table like this is red flags signaling one extreme or another. The only flashing light I see here is in the smaller group, where one or a few firms are having problems and pulling the average down to danger levels. As to WMT, it’s OK to go back to sleep.

So let’s get back to the question posed by the heading to this section: Does WMT’s get-tough-with-vendors stance make sense?

Knowing as I do the horrors that befall stockholders when companies miss guidance, or don’t guide as high as the Street wants is to guide, and understanding the traumas likely for company managers dreaming of bonuses and fearing layoffs if they don’t deliver on internal targets, it’s hard for me to dis anyone at WMT for trying to squeeze more numbers out of its operation than are being squeezing today.

But in the grand scheme of things, the extra $1 billion in revenue WMT projects is less than a zit on an elephant’s rear end even if for one or more WMT managers, it may be their entire careers. And with WMT employees looking to get their hands on a few more of those numbers than they’ve gotten in the past, I can empathize with WMT managers feeling pressed to recapture those pounds of flesh by looking to others from who they can be extracted. (Congratulations suppliers, you’re elected!)

How Investors Should React

Many equity investors take it for granted that growth is a must. If we can get a nice yield, or find an unduly low stock valuation, great, but companies have to grow.

Growth really is desirable. It’s key to what separates stocks from fixed income or even preferred stock. Realistically, though and drilling down to the level of an individual company, we cannot expect each and every business to always grow. The best buggy whip manufacturer is still a buggy whip manufacturer and no financial theory in the world can make it grow. It can exit the buggy whip business, start or acquire a virtual-reality gizmo company, rename itself BW Virtual Reality Co. (the BW being a way to pay homage to its buggy ship heritage) and grow that way. But I don’t think this is what WMT has in mind and even if it did, I’m not sure investors would accept such a strategy from that team of managers and executives.

The basic reality for WMT is that it is not a growth company anymore and no amount of stomping on employees or now suppliers is going to change that. The 0.21% pop to revenues WMT projects from OTIF certainly won’t do it, and Tables 1 through 4 give little reason to expect such nickel-and-dime nonsense to somehow or other put things right for WMT. Its business is what it is.

Moreover, WMT is already right – as long as we understand and accept what WMT is and refrain from pining away over what it’s not. It’s not AMZN. Different era. Different business model. Different skill set. This isn’t called a failure on WMT’s part. Instead, we call it life, or the human experience.

Consider the flow or funds data in Table 5.

Table 5 (in $ mill.)

Data from S&P Compustat via Portfolio123.com and reflects Compustat standardization protocols. Fiscal years end in Jan.

The seven-year combined surplus is equal to about $12 billion and works out to 6.5% of the total cash from operations over that period.

Dividends, share buybacks and changes in debt amounted to $85.7 million or 47% of overall cash from operations.

This picture consisting as it does of heavy outflows to the capital markets depicts a company that, whatever its Investor Relations team may say, knows full well where it stands in terms of the business life cycle

So let’s get real: WMT’s OTIF program is an example of a dog chasing its own tail and pretending its going somewhere.

Actually, that’s the best-case scenario. Worse case scenarios are that suppliers decide that have to rise prices to pay for the extra expense they’ll incur in complying or for the fines they’ll pay (many suppliers are just like WMT in that they have managers who need bonuses and shareholders who demand they meet or beat strong guidance). Smaller suppliers may decide they can’t afford to sell to WMT and simply drop out and focus on AMZN, leaving WMT with better stocked shelves but also with lesser variety and/or higher prices.

If WMT doesn’t REALLY need all of its capital spending (i.e. if there are other dogs-chasing-their-tails projects that can be scrapped), it can afford to raise the dividend and help the stock price that way. If WMT’s dividend is already as high as it can legitimately be (assuming the company absolutely positively won’t substitute more dividend for scatter-shot share buybacks), then perhaps the current 2.8% yield is too low given the likelihood the market may be overestimating dividend growth prospects. But that’s not an issue for WMT to address. It’s for the investment community to decide whether or not the stock should be pushed down to the point where we have a better balance between current yield, credible dividend growth prospects, and very low dividend risk.