Being Long on Wal-Mart Is Wrong

 | Aug 03, 2011 | 7:30 AM EDT
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A downgrade by Jeffries to Hold from Buy put Wal-Mart (WMT) shares in the market's spotlight today. I won't dive too deep into my views on the Wall Street ratings system (briefly, I would say that type of downgrade means to sell the stock and seek more promising opportunities elsewhere, not hold a stock that is akin to dead money). If you are inclined to visit the Bloomberg or Thomson Reuters consensus rundown, it will show that I have been the lone analyst on Wall Street carrying a Sell rating on the stock -- since Dec. 17, 2010. My reasons for this may be help you -- the investor who is being told to hold a stock that yesterday was rated a Buy -- to fully appreciate what is happening at the company and why I am saying to avoid shares in the world's largest retailer.

For a retail giant that is basically everywhere in the U.S. and is making strong inroads into the international scene, Wal-Mart's stock price has been anything but fresh and easy for an investor's portfolio. Since peaking at a 52-week high on Jan. 28, Wal-Mart stock has fallen 8.3% compared to the S&P 500, notching a modest loss. Keep in mind this is despite a massive $15 billion share repurchase program looming over the earnings line like a thundershower on a 105-degree day.

So what's the deal? Wal-Mart's shares, beloved by many on the Street, are trading on a 10.6x forward price-to-earnings ratio (P/E) multiple and sporting a 2.8% dividend yield. Yet investors are still unable to catch a bid. This has happened in view of a weakening employment picture that theoretically should favor Wal-Mart's business model (price perception has become an issue). Oddly enough, Wal-Mart shares may have foreshadowed the short-term peak in monthly job creation: The stock began to languish from Jan. 28 just as we were about to enter a couple of months of 100,000 plus in non-farm payroll growth. Seven months later, our country is now two disappointing payroll reports in the hole.

Here is my breakdown for why being long is wrong on Wal-Mart:

1. Dollar stores, such as Dollar General (DG) and Family Dollar (FDO), have printed strong same-store sales recently, which suggests that Wal-Mart is still not receiving fill-in visits between paycheck periods. Therefore, price perception in spite of the new price match campaign is looking like an issue. Did you ever think a day would come where Wal-Mart would be viewed as expensive? The time may be upon us, and it's very much a function of the type of jobs recovery we are experiencing.

2. Target (TGT) is continuing to struggle selling anything that could be deemed discretionary.

3. Family Dollar recently reiterated Wal-Mart's declaration of a pronounced paycheck cycle, in which low-income consumers err on the side of caution.

4. Dollar General and Family Dollar have experienced gross margin misses due to inflation and weak seasonal sales.

5. Wal-Mart is focusing on price match in the U.S. and global everyday low price initiatives (the margin is unfavorable).

6. Wal-Mart's ASDA U.K. business is facing challenging market conditions.

7. Import inflation has changed the "buy for less, sell for less" dynamics of Wal-Mart's business.

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