Once financial engineering fails, all bets are off
by Wolf Richter
Wal-Mart had a bad-hair day. Its shares plunged $6.71, the largest single-day cliff-dive in its illustrious history. They ended the day down 10%, at $60.02, a number first kissed in 2001. Shares are 34% off their peak in January. So it wasn’t just today.
But Wal-Mart didn’t do anything that special at its annual investor meeting today. It announced big “capital investments,” (we’ll get to the quotation marks in a moment), a crummy outlook, and a huge share buyback program. All of which it has done many times before. Only this time, the outlook is even worse, but the promised share buybacks are even larger.
Wal-Mart proffered its strategies on how it would try to boost revenue growth in an environment where its primary customers – the 80% that got trampled by the Fed’s policies – are struggling to make ends meet. A problem Wal-Mart has had for years.
The news release hints at these new initiatives, spells out costs, and forecasts the resulting earnings debacle.
Wal-Mart will goose “capital investments” by $11 billion in Fiscal 2017, on top of the $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.
So sales in fiscal 2016 would be flat, which Wal-Mart blamed on “currency exchange fluctuations.” Would that be the strong dollar? But sales were also flat for the prior three fiscal years when the dollar was weak. Don’t lose hope, however. In the future, starting in fiscal 2017, sales would edge up 3% to 4%. To accomplish this, management is now desperately praying for inflation.
The most chilling words in the news release? “These are exciting times in retail given the pace and magnitude of change.”
Then there was the announcement of a $20-billion share buyback program. $8.6 billion remaining from the $15 billion buyback program authorized in 2013 would be retired. That $15-billion program was on top of $36 billion in buyback programs over the preceding four years. Buybacks is what Wal-Mart does best.
At the time – over two years ago – Bloomberg put it this way:
The world’s largest retailer is grappling with myriad challenges. Wal-Mart is trying to goose slowing sales gains in the U.S. as such rivals as Amazon.com Inc. and the dollar stores lure its customers. Overseas, the company is struggling to ignite growth in China and other emerging markets even as it probes allegations of bribery in Mexico and possible violations of the Foreign Corrupt Practices Act.
Wal-Mart is also contending with increasingly restive labor groups clamoring for better working conditions. Protesters from OUR Walmart, a union-backed organization of employees, descended on Bentonville this week.
Hence the recent and future pay increases that have somehow become “capital investments.” Bloomberg also noted at the time:
The buybacks have pushed the founding Walton family’s stake in the company past 50%, giving Wal-Mart the right under New York Stock Exchange rules to have a minority of independent directors on the board. The company has said it has no plans to take advantage of the rules.
So Wal-Mart has faced the same difficulties in this Fed-designed economy for years. Wal-Mart’s primary customers, the lower 80% on the income scale, have practically no savings, and every month is a battle to make ends meet. It is hard to increase sales when your customers are this strung-out – not just in the US but in its markets around the globe
And that’s what has happened. Sales and profits have languished for years. Worse than “languished”: profits actually fell 3.7% over the past three fiscal years. Disappointment after disappointment.
But thanks to these giant buyback programs and the megatons of Wall Street hype associated with them, and thanks to QE, shares have climbed 75% from 2011 to January 2015. No growth no problem! Share buybacks overcome all sins.
But since January, the math has stopped working. Today, Wal-Mart projected a worse earnings debacle than before but offered an even bigger share buyback program than before. Share buybacks pumped up the shares back then successfully. But they haven’t recently. And they didn’t today. Something changed.
Share buybacks, usually funded with borrowed money, have been among the most powerful forces behind the multi-year stock market rally. It has been the most successful method of financial engineering. It worked practically every time. It didn’t matter that revenues and earnings were going to heck as long as the share buybacks were big enough.
If that scheme has lost its appeal, and if Wal-Mart is a harbinger of how financial engineering fails to boost share prices of revenue-and-earnings challenged companies – which includes much of the S&P 500 – then more stocks, one after the other or perhaps together, will fall off their precariously swaying perch. In this era, once financial engineering fails to prop up stock prices, all bets are off.
So now, junk-rated, money-losing, revenue-challenged Dell tries to pull off its own giant piece of financial engineering. Read… Peak Desperation