Wal-Mart Shares Plunge 10 Percent; Retail Price Wars On the Way? Capital Investment Financial Engineering

Wal-Mart Shares plunged 10% Wednesday on profit warnings, the biggest one day decline in 25 years. The company blamed higher wages, e-commerce competition, and lower prices.

Wal-Mart Chief Executive Doug McMillon said a $1.5 billion investment in wages and training, including raising the minimum store wage to $10 an hour from $9, were needed to improve customer service and would account for three-quarters of the expected 6 percent to 12 percent drop in earnings per share next year.

Wal-Mart also announced a $20 billion share buyback but the drop in its share price wiped out close to the same amount in market value, and the 10 percent drop was the worst one-day percentage performance since January 1988.

The world's largest retailer by revenue said it would invest several billion dollars to lower prices over the next three years. That sparked worries of a price war, and shares of rivals including Target and Home Depot also fell.

The company is building out a network of warehouses to handle e-commerce, a costly move Wal-Mart sees as essential to stopping Amazon and other rivals from stealing its best customers.

At the same time Wal-Mart projected slower growth in new stores, with 85-95 of the smaller Neighborhood Markets format planned for the fiscal year ending in January 2017, down from 160-170 planned for the current fiscal year. Supercenter openings would slow to 50-60 in fiscal 2017 from 60-70 this year.

Price competition was one reason for the slower growth. Foran said that Wal-Mart could not compete with local grocers in some markets, a factor that has played into its scaled back expansion plans for smaller stores.

Capital Investment Financial Engineering

In a press release Wal-Mart announced "Capital investments will be approximately $11.0 billion for fiscal year 2017 and will remain flat in fiscal years 2018 and 2019. This is below the revised fiscal year 2016 estimate of approximately $12.4 billion, primarily due to a moderation of physical store expansion."

Wolf Richter took Wal-Mart to task for that statement in his appraisal The Chilling Thing Wal-Mart Said about Financial Engineering.

Wal-Mart will goose “capital investments” by $11 billion in Fiscal 2017, on top of the $16.4 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.

Then there was the announcement of a $20-billion share buyback program.

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.

Retail Price Wars On the Way?

It appears so, as Wal-Mart clearly intends to go head to head with Amazon. That's good for consumers of course, but the Fed will not see it that way.

Consumers actually need price relief given rents are soaring out of sight and are seriously under-counted in the CPI.

For details on rents, please see Hooray! Huge Rent Hikes Coming; How Will It Affect Price Inflation?

Weakening Economy

Regardless of how one views inflation, this economy is getting weaker and weaker.

Following two weak economic reports on Tuesday, the first on retail sales, the second on business sales, Rate Hike Odds for March 2016, Fell Below 50% as GDP Forecast Slipped to 0.9%.

Mike "Mish" Shedlock