4 reasons why Walmart's sell-off is an opportunity for investors willing to be a little patient

Published Sat, Feb 20 20217:55 AM EST

Melissa Repko @in/melissa-repko @melissa_repko

Key Points

Walmart's latest earnings report and plans to invest $14 billion in its business prompted a sell-off that has wiped $25 billion from the retailer's stock.
The big-box retailer said it sees growth opportunities in businesses like advertising and health care.
It also is automating its business to allow it to fulfill online orders more efficiently.

On Wall Street, many investors voted with their feet Thursday: They sold off Walmart shares as the company missed fourth-quarter earnings estimates , gave a disappointing outlook and warned some stay-at-home pandemic trends may be fading. Since the news broke, more than $25 billion in market cap has vanished. Shares closed Friday at $138.34, valuing Walmart at $391.4 billion. The stock is up more than 17% over the past year, but it's well off its 52-week high of $153.66, which it set on Dec. 1. One of the biggest issues is the $14 billion Walmart wants to invest in its business as it ramps up automation, improves its supply chain and adds new customer services. Walmart CEO Doug McMillon tried to persuade investors that it's the right decision at the right time. He said he wants to tap new opportunities that will lift the retailer's bread-and-butter business of selling groceries and other merchandise. Simeon Gutman, a Morgan Stanley retail analyst, said the company's investments will weigh it down for the short term, but set it up for the future as it fends off traditional players and threats like Amazon . The firm rates Walmart as overweight. It lowered its price target by $2 to $154, but that represents a nearly 10% gain from where shares are currently trading. "The underlying message is 'We just had a very successful 2020,'" he said. "Rather than let some of that harvest, we're going to plow it back in and drill down and make our competitive advantage even stronger." Here are four reasons why the company's strategy could be an opportunity for long-term investors: Walmart's reach gives it a leg up in the ads business. Walmart is the nation's largest retailer and private employer. More than 90% of Americans live within 10 miles of the company's stores. About 150 million people go to its stores, website or apps every week. For the retailer, that reach is a revenue opportunity . It wants to become one of the top 10 advertising platforms in the U.S. and surpass big players like Hearst, Fox and Twitter in the next five years, CFO Brett Biggs told investors Thursday. To grow that business, it will amplify efforts to sell ads space on its app and website. It will also sell them on TV and checkout screens in stores — and even tailor them to local weather or customer preferences. For example, it could promote a soup or hot chocolate brand on a snowy day or have a targeted ad for diapers appear on the self-checkout screen for a parent who regularly buys baby food. Brian Yarbrough, consumer retail analyst at Edward Jones, rates the company as neutral, but said he sees advertising as a "massive opportunity" for the retailer. He said Walmart can track customer purchases in stores and online, allowing it to better target ads to the right customers and show advertisers the return on their investment. And, he said, advertisers are looking to diversify beyond Facebook and Google , dominant players in the ad business. "That's in my mind the biggest gamechanger in profitability because it's such a high-margin business," Yarbrough said. Covid-19 vaccines spotlight Walmart's growing health-care business. In a new TV commercial, Walmart touts a role it wants to play in more communities: Health-care provider. The video shows pharmacists in lab coats and said the company is ready to administer Covid shots. The retailer has gradually been expanding its health-care business. It already has pharmacies inside of thousands of its Supercenters and Sam's Club locations. It's opened 20 Walmart Health clinics next to its stores, which offer low-priced therapy sessions, dental checkups and doctor appointments. It recently broke into the insurance business by registering to sells supplemental Medicare insurance . Most of that expansion has happened with little fanfare or flash. At this week's investor day, McMillon struck a different tone. He spoke about Walmart's big ambitions and described health care as a natural fit, since the company is known for low prices, trusted by many families and has large parking lots that can support health clinics. With Covid vaccines, Walmart will step further into the health-care spotlight. Some of its pharmacies are receiving direct shipments of doses as part of a federal program. Jefferies analyst Steph Wissink said in a research note that administering the vaccines "fits squarely with the [company's] strategy to be an accessible and affordable provider for basic healthcare." She said the retailer's proximity to much of the U.S. population gives it a built-in advantage. Plus, she said vaccines and medical appointments can drive foot traffic into its stores. She's rated Walmart as buy, with a $180 price target and called the market's pullback on its stock "a rare 'rollback' opportunity." Stores are becoming mini warehouses for profitable e-commerce growth. Along with selling merchandise on the sales floor, Walmart is turning dozens of its stores into mini warehouses . They will have automated systems that pair up robots and employees. Robots pick common items in the back of the store and personal shoppers gather bulk or fresh items, such as steak, on the sales floor. Walmart did not specify how many stores will get the automated systems, but said they're part of its capital expenditures for the year ahead. Walmart's e-commerce business has had sharp growth, particularly during the pandemic, but is not profitable. Michael Lasser, a UBS retail analyst, said automation brings the company a step closer by fulfilling curbside pickup and home delivery orders more efficiently. The retailer currently uses people to pick and pack each online order, which increases labor costs and makes it hard to keep up with high demand. His rating is buy and price target for the company is $165. With the automated systems, he said, Walmart can handle a heavier volume of online orders and improve the customer experience. Not only will shoppers get their groceries and other items faster, he said. When they go to stores, they'll have fewer personal shoppers crowding the aisles. Walmart+ can woo customers and win more of wallets. Walmart wants to have a more powerful pull, even among its current customers. One way it aims to do that is Walmart+, a subscription service that it launched in the fall . It costs $98 a year or $12.95 for a month of service. The retailer hasn't shared the number of subscribers, but a Consumer Intelligence Research Partners analysis estimated that it has 7.4 million to 8.2 million customers so far. That's a small number compared with rival, Amazon Prime, which has grown to approximately 126 million U.S. subscribers as of October, according to a CIRP estimate. That service has a 15-year advantage, though, and indicates the stickiness of membership programs and their potential to grow. Lasser of UBS said Walmart+ will entice customers to spend more with the retailer, similar to Amazon Prime, because the company will be top of mind. "It allows them to capture more share of their existing customer, more share of their wallet and grab new customers," he said. Gutman said the service creates built-in recurring revenue — a factor that investors typically like. And he said, its central perks — unlimited home grocery delivery and free shipping — could win over middle- and upper-income families that are new or occasional Walmart shoppers and turn them into frequent buyers. No doubt, Walmart's investments may take a while to pan out, and they could flop. Also, the boost it received from the pandemic makes gauging its growth all the more challenging. Last fiscal year, Walmart grew its revenue by $35 billion. "That is the thing that the entire Street is wrestling with," said Edward Jones' Yarbrough. "How many years of growth did these companies pull forward? Could you have a period where you have two or three years of flattish sales and flattish earnings? Eventually you are going to have to comp those comps and they are going to be difficult." —CNBC's Christopher Hayes contributed to this report.

Cars drive past a Walmart store in Washington, DC, on August 18, 2020.

Nicholas Kamm | AFP | Getty Images

Since the news broke, more than $25 billion in market cap has vanished. Shares closed Friday at $138.34, valuing Walmart at $391.4 billion. The stock is up more than 17% over the past year, but it's well off its 52-week high of $153.66, which it set on Dec. 1.

One of the biggest issues is the $14 billion Walmart wants to invest in its business as it ramps up automation, improves its supply chain and adds new customer services. Walmart CEO Doug McMillon tried to persuade investors that it's the right decision at the right time. He said he wants to tap new opportunities that will lift the retailer's bread-and-butter business of selling groceries and other merchandise.

Simeon Gutman, a Morgan Stanley retail analyst, said the company's investments will weigh it down for the short term, but set it up for the future as it fends off traditional players and threats like Amazon. The firm rates Walmart as overweight. It lowered its price target by $2 to $154, but that represents a nearly 10% gain from where shares are currently trading.

"The underlying message is 'We just had a very successful 2020,'" he said. "Rather than let some of that harvest, we're going to plow it back in and drill down and make our competitive advantage even stronger."

Here are four reasons why the company's strategy could be an opportunity for long-term investors: