Early this week, Walmart’s share price dropped a whopping 8.51% in a matter of seconds. That makes it the stock’s 4th worst day in the past 20 years – and since they’re the country’s single largest employer, that’s pretty gargantuan news.
Why The Panic?
This came in response to the company’s earnings call this week, where they admitted that “food inflation… is affecting customers’ ability to spend on general merchandise categories and requiring more markdowns to move through the inventory, particularly apparel.”
Or in plain English: Walmart has so much stuff on their shelves people are not buying that they need to mark down prices just to clear out their inventory. And that means lower profits until they can clear out their overstock.
But Walmart is famous for their supply chain management, and they have been in the game for a very long time. A miscalculation this big raises eyebrows everywhere – especially among WMT holders. So…
Why Is This Happening?
The problem comes from a mismatch between demand forecasting and order placement for the stuff that Walmart sells. Inventory management is a ballet of coordination, and it doesn’t take a lot to throw it off. In this case it was heinously derailed by, yep, you guessed it… COVID.
Walmart is hardly the only victim, however. Target made a similar announcement last month, and investor Michael Burry (of The Big Short fame) had a key insight about that:
The Bullwhip Effect happens when a sudden change in consumer behavior has increasingly massive impacts on retailers and manufacturers further up the supply chain. When consumer demand for certain goods starts to change, retailers like Walmart try to get ahead by ordering more or less of the product in question before the shift happens.
Think of a store that sells Halloween costumes; they must buy their product months in advance to have it ready in time. But unlike Halloween stores, most retailers and suppliers don’t have demand shifts for their products already set on the calendar. So they have to make longer- and longer-term bets on what consumers will do, with bigger and bigger consequences when they bet wrong.
A prime example of this might be… oh I don’t know… a complete lockdown due to a global contagion, followed by the sudden reversal of said lockdown.
During COVID, consumers stopped buying airplane tickets and reallocated their spending toward home improvement. Then, when lockdowns eased, they switched back to normal, pre-COVID spending habits. But meanwhile, retailers had to keep ordering stuff from their wholesalers – months in advance – that was in high demand at the time, like TV’s and patio furniture. Same deal with wholesalers and manufacturers.
The bad news is obvious: large retailers will have to clear out their stock of unwanted merchandise by selling it at massive discounts. In my opinion, the right move for them is to quickly rip off this Band-Aid and realize their losses now, rather than dragging it out.
From an investor’s perspective, this will have a temporary impact on profits. Walmart and other retailers expect it to last only for the next two quarters before returning to equilibrium – just a blink in the world of investing. In fact, at the time of this writing, WMT’s price has almost fully recovered already.
If nothing else, the good news is that this will likely have a material impact on lowering inflation. And you can finally build that home-theater you have always wanted on the cheap! There’s a silver lining to everything.