Episode Transcript
[00:00:00] Speaker A: The markets, we just can't get enough of them.
[00:00:02] Speaker B: Markets are the drivers of your wealth and investment strategy.
[00:00:06] Speaker A: Welcome to Magic Markets with your co hosts, the Finance Ghost and Mohammed Nala. Welcome to episode 288 of Magic Markets. I'm your co host, the Finance Ghost here as always with Mohamed Nala. Trying a few new things this week. It's going to be nice and punchy. We've each got certain things that we've brought to the show. Mo will be unpacking why the US treasury has stepped into the long end of the bond market, what it can and cannot achieve and why elevated yields still matter for everything from mortgages to equity valuations. And I'll be dealing with Walmart and all the things we can learn from their latest results, which were, I must say, very interesting. So, Mo, over to you with your macro overview. I'm excited to learn from you this week.
[00:00:46] Speaker B: Absolutely. Ghost, let's jump straight in because the biggest story last week in the markets was certainly the US treasury stepping into the bond market and it's really looking at intervening at the long end of the yield curve. I'm going to unpack that firstly starting off with the fact that before this announcement, the 30 year US treasury yield briefly moved around 5.4% and that is its highest level since 2007.
Now this is important because that 30 year benchmark is really the one that feeds into mortgage rates. It feeds into corporate borrowing costs, property valuations and, and effectively your long end discount rate for long duration equities. So when the long end moves sharply higher, it's effectively tightening financial conditions even if the Fed itself is doing nothing.
Now, there's also a global element here. It's not just a US move. We've seen Japanese, German, French yields, they're all hitting multi year or in some cases multi decade highs. So investors in the market are clearly demanding more compensation to hold long dated sovereign debt. Now, the drivers are all familiar. We've got oil above 90 at the moment. You've got inflation risks, a very heavy government borrowing and large deficits. And then you've also got corporate issuance which is linked to AI and this data center theme we've spoken a lot about, that's also coming through at the longer end of the yield curve in a time when you have fairly thin liquidity in North American summer. So this was really the perfect setup for those bond yields to be pushing substantially higher. And, and long story short is that that long end was becoming too uncomfortable. The Fed hasn't been doing anything much and so the US treasury decided they're gonna step in here and they announced around midweek last week that they're gonna be targeting an increase in the long end buybacks. They currently do do that, but they've moved the maximum size of certain operations from $2 billion to $4 billion per operation. And this targets the bonds that sit in the 10 to 20 year bucket as well as the 20 to 30 year bucket. Now, the market's reaction initially is that it liked it. The 10 year yield fell around 6 basis points, the 30 year falling a little bit more by around 10 basis points. And so that's a yield curve flattening. It's called a bull flattener. That came through because the long end outperformed. But that rally ended very quickly. And by the end of the week you actually saw most of those gains actually given back. Not all of them, but most of them. And that tells you that the market says yes, maybe this is helpful, but, but it's not enough to actually change the overall direction now to maybe unpack. How is the treasury going to go about doing this? They're mostly buying those older, less liquid bonds. They're the off the run Treasuries, the ones that are maybe not as liquid. And so they're looking at addressing that liquidity problem where the spreads are maybe a little bit wider. And they effectively say, we're in the market over here and if you are someone holding this, show us your best offer and if we like it, we're going to take that. This is why I would say it's sort of qesque, but it's not really qe. And what are the main differences between quantitative easing, which is something that was run by the Fed and what's happening right here, is that the Fed effectively creates reserves by buying assets on a much larger scale. The Fed runs in the hundreds of billions, if not trillions of dollars. This is not the Fed, this is the U.S. treasury. And that's very important to note because this is a debt management tool. And the scale obviously a lot smaller. As I mentioned, tens of billions, not hundreds of billions. And so that's one of the key differences. The other thing is that is it similar to the operation twist that we saw the Fed perform a little while ago where they effectively tried to flatten that yield curve out? I would say yes, it's somewhat similar in that longer end liabilities, that supply will be reduced, shorter liabilities might rise, but this is much smaller. And as I mentioned, treasury funded. Now what does this mean for Investors, it means that the 20 and 30 year part of the curve could get some tactical support. Is it a bit of a soft put by the U.S. treasury? Yes, the, the curve can flatten for a while if that long end outperforms. But you may also see that the sell offs that we've been experiencing in the long end of the curve may become a little bit more stop start. And that's because the market now knows that the treasury is certainly willing and able to actually intervene in that market. And I think it's important to note over the longer term, because now I want to zoom all the way back out as I wrap this up, is that this doesn't solve the long term problem that has actually pushed the yield curve and yields in general to, to the levels we're seeing right now. It's a short term fix. It might flatten the yield curve, but it doesn't solve inflation, it doesn't solve the deficit, it doesn't solve the government's total borrowing requirement and the large deficits that you're seeing there. And so the investors would probably look through that. That's certainly what you saw coming through in the market last week, certainly with the fact that that rally was short lived. And so it might slow the rise in long term yields, but it doesn't fix the overall problem.
Now why is all of this important at the end of the day? Is that the long end yields, as I mentioned, it's one of the biggest swing factors in the market. If the long end stays elevated, it's going to pressure housing. We've seen some of that come through that pressures REITs, it's going to pressure corporate debt. I mentioned a lot of issuance coming through. It also pressures other vulnerable sectors of the market like the private equity sector. Just watch that. Because if these rates stay as high as they are, that's going to come through a little bit of pressure. And so I would say wrapping it up, the Treasury's put a speed bump in front of the long end of the yield curve. We might actually see that pause things in the shorter term. It helps the plumbing doesn't solve the underlying problems at the end of the day. And I think what really matters is that can consumers stay resilient enough to ride out what has effectively been a higher cost of money world versus the zero interest rate era that we had a little while back. I think that's a nice way to segue across to, to you looking at Walmart because that's going to give us a nice lens in terms of how the consumer is actually faring in these market conditions.
[00:06:30] Speaker A: Thanks, Mo. Exactly. Let's jump into Walmart now. They released results on the 20th of August which marked the halfway point in their financial year. Share price up around 6% over 12 months. When I prepped for this, it got whacked by 9% on the day of release. So the market did not like it EBIT multiple below 28 times, which is only a little bit higher than the three year mean of 26.7. So the share price has come under some pressure in the aftermath of these results and interestingly it's despite the fact that there's actually a lot of really impressive underlying fundamentals going on here. The share price has managed the CAGR, I must point out of almost 19% over five years. So it has been a very good performer with a longer term lens. Plus you get a small divvy of around 1% yield. So something has spooked the market in the latest numbers. But before that Walmart had come into this on quite a streak.
So what didn't the market like? It seems to be the US sales growth that really set the hairs running here. On a comparable basis, excluding fuel, it grew 2.6% in the U.S. that metric, that's well below analyst expectations that were more like 3 1/2 percent. And Walmart has blamed healthcare sales here impacted by regulatory pricing action. And when we do the deep dives in magic markets premium, we always look at companies that have regulated pricing and highlight this as a risk. If they can't always set their own prices, they can't always protect their own margins. Now on the plus side, and another regulatory issue, they've just achieved operating income growth in the US of around 10% excluding tariff refunds. And if you actually add in the tariff refunds then you'll get 17.9%. So the tariffs themselves responsible for over 750 basis points. It's quite a number. They describe this as the best leverage they've seen in the US comparable numbers in two decades and that's if you exclude the tariff refunds. So really good job there that they are doing. However, I'm not sure you can actually make that claim because part of the reason for that comparable sales growth, that 2.6% excluding fuel, is that they've gone and reinvested the tariff refunds in the price. So I don't think it's fair to say while we grow our sales 2.6%, we grew our operating income 10% ignoring tariffs because in reality the tariffs actually help them drive the sales growth. So it's a bit messy, but there is some good leverage underneath all of this and well done to them. They had 11,000 rollbacks during the quarter. That's 11,000 items where the price was decreased. It's quite amazing.
So bigger picture here. Gross margin has been 24 to 25% year after year. Operating margin between 4 and 4 and a half percent. Net income margin between 2% and 3%. So really consistent performer over the years. And that's an important thing to keep in mind. When you look at these latest numbers, you consider the skew from the tariffs and what this might be doing to the US based numbers. It is also amazing to think, by the way, that for every dollar that goes through a till at Walmart, only 2 to 3 US cents actually lands in the hands of shareholders as a profit. It's amazing how small these margins actually are. And only 35% of that number will then hit them as a dividend. The rest is reinvested for growth or used for share repurchases. And there's plenty of capex here that they need that money for. So that's why the payout ratio is relatively low.
Over the past 12 months, Walmart has put $29.4 billion into capex versus 7.7 billion into dividends and nearly 7 billion into share repurchases. So pretty capex heavy model here. Growing out that footprint is no joke. But shareholders not really complaining because return on equity at Walmart is up at 22.3% from mid teens during the pandemic and it's also up versus pre pandemic levels.
Yes, it is a structurally more leveraged balance sheet than before the pandemic and obviously that is affecting ROE positively here. But there's a modest uptick in return on assets as well. Another very important point I need to cover in this podcast is E commerce that is a big growth engine at Walmart, up 23% year on year in the latest quarter. That is the 10th consecutive quarter of growth of over 20% for that business. Really, really impressive. That's in the U.S. in particular.
And they use that to drive things like memberships in Sam's Club for example, which is their warehouse operation that competes with Costco and the related loyalty benefits. Plus they push advertising revenue up 38%. Another thing to just touch on quickly, third party marketplace that helps them drive activity on this platform without having to take inventory risk. And nearly 50% of marketplace business flowed through Walmart fulfillment services. That's another source of revenue That's Walmart building out their distribution network and then offering it to third party sellers. And speed absolutely matters here because fast delivery in the US up 48% for the quarter. Never mind the 60 minute promise in South Africa, we're talking sub 30 minute delivery in 38 markets in the US. That gives you an idea of how impressive this actually is. Touching on a couple more points. International sales up 7.9% led by China and India.
Love to see South Africa on that list but we can really only dream now, bring it all together. And operating income growth was actually right at the top end of their guidance of 7 to 10%.
And they actually feel so good about the numbers that have come through that they've just raised their guidance. They've gone for 4 to 5% sales growth for the year, up from 3 and a half to 4 and a half percent previously. Operating income growth they now say will be 7% to 8.5% versus 6% to 8% previously. And yet the share price came off really hard. So was that share price knock somewhat overcooked here? Was the market just getting scared about a comparable sales number without actually reading through all the leverage, all the benefits that Walmart is unlocking in its business, how impressive that E commerce story is? Or is this just a function of a really hot valuation? These are very high multiples so any miss versus analyst estimates is going to be punished. Even if management says hey don't worry about it, the full year is going to be great. So very interesting dislocation here in Walmart. Moen I think something to just keep on the radar.
[00:12:32] Speaker B: Indeed, Ghost. I mean Walmart is a stock that I liked throughout most of last year. In fact I had preferred that over Costco. And then earlier this year we actually saw the wheels coming off at all. But you saw that stock underperforming the likes of Costco and again different issues behind what's driving that move. I think to just wrap up the show, you know, on my section, treasury trying to calm the cost of money problem. Walmart giving us a real world read on whether the consumer, consumer can actually keep absorbing it. And based on their outlook, they're not as concerned as maybe other sectors of the market in terms of the consumer health going forward. Let's watch that very closely. We'll leave it there for this week. Let us know what you thought of the show. Hit us up on social Media. It's at MagicMarketsPod. One word at Finance Ghost Mohammed Nala all on X or go and find us on LinkedIn pop us a note on there. Until next week, same time, same place. Thanks and cheers.
[00:13:19] Speaker A: Ciao. This podcast is for informational purpose purposes only and is not financial or investment advice.
Please speak to your personal financial advisor.
