Summary
Wal-Mart Pay is dramatically superior to the incomplete product being pushed by Merchant Customer Exchange.
The solution still allows customers to use the credit card linked to their account, which is a big plus for consumers.
The biggest weakness is a lack of NFC, needing to open an app, and still needing to pay credit card companies their fee.
Wal-Mart may encourage shoppers to use an account directly with Wal-Mart rather than using the credit card, so there is some potential.
Wal-Mart Stores, Inc. (NYSE:WMT) is rolling out a new way for customers to pay. Since Wal-Mart shares fell to around sixty bucks I've been a fairly large bull on the stock since I see the company declaring weak earnings per share despite growing sales as a function of weak operating margins. This new option for payment strategies has the potential to enhance margins, but it is going to be tricky.
Margins
The weak operating margins don't concern me much because the costs are driven significantly by higher pay for their workers. I expect labor quality to improve over time due to the higher wages making it easier to retain talented workers. Therefore, I expect margins to naturally expand back towards their previous levels around 2018. While investors wait, the company is paying out a nice 3% dividend yield and repurchasing a high volume of shares at substantially lower prices which should drive factors like "sales per share" materially higher. If the operating margins recover, as I expect them to, then the stronger sales per share should translate into material growth in earnings per share.
Keep in mind that Wal-Mart operates on extremely thin margins. Shaving even half a percent off their operating expenses would make a material difference in the full year earnings per share. While Wal-Mart is an established dividend champion and has an enormous presence, the company has seen shares decimated because of the hit earnings took over operating expenses expanding slightly. When a company runs on razor thin profit margins, this is simply part of the business.
Merchant Customer Exchange
Merchant Customer Exchange was supposed to be the answer for retail companies wanting to internalize the transaction process. Merchant Customer Exchange was designed by a consortium of the largest retail giants. It offered pretty much everything that retailers might consider highly important in a payment solution. It allowed the retailers to easily track the customer and monitor their shopping habits; it completely removed credit cards by attaching to the customer's bank account. It was a solution to enhance margins and improve the amount of data available on customers. The problem was that Merchant Customer Exchange was a terrible plan from the start. While it offered everything the retail giants wanted, it was late to the party (still not released), way behind in technology (no "Near Field Communication"), and offered precisely zero compelling reasons for customers to want it.
Wal-Mart Pay
When I heard Wal-Mart was moving ahead with their own payment plan, I was concerned they might try to just use an updated version of the Merchant Customer Exchange system. That sounded like a disaster. It doesn't matter which company tried to push the system for excluding Visa (NYSE:V) and MasterCard (NYSE:MA). Customers want to use their credit cards for both the rewards they offer and the protection they offer. For a company I ran quite a few years ago, a group of thieves hacked into one of my supplier's databases. That supplier never fessed up, but I had a few guesses since I only used the card with a handful of companies. The process for shutting down the credit card was fairly simple. It should be no surprise that I don't want companies to have access to my checking account information.
Rather than trying to force the Merchant Customer Exchange method, Wal-Mart went an entirely different direction. Their solution still has some weaknesses since it does not utilize NFC which makes it slower to process transactions. Customers are still forced to unlock the phone, open an app, and scan a QR code, which means this will generally be slower than swiping a credit card.
On the other hand, Wal-Mart Pay will have some substantial changes from the expected system. According to the WSJ:
"Daniel Eckert, Wal-Mart's head of services for the U.S., said the retailer decided to build its own payment system because the other options either only work on particular smartphones or only allow users to pay with a select group of credit or debit cards.
Wal-Mart wanted to create something 'that allows customers to use any credit, debit, prepaid card, just as they would normally do if it were plastic,' said Mr. Eckert. About 75% of Wal-Mart shoppers own a smartphone, he said."
The strategy Wal-Mart is pursuing would simply allow users to check out with their phone by processing the transaction on whichever credit cards they had saved to their account. This offers some benefits to Wal-Mart's ability to track shopping behavior because it would link the online account with the shopper in person.
By avoiding the physical swipe of the card, Wal-Mart may also be able to reduce the exposure to fraudulent purchases.
Potential Gains
In my view, the potential gains here would be limited if Wal-Mart were just going to stick to reducing fraud. My expectation for Wal-Mart is that they will improve the system within the next year or two by offering customers rewards if they choose to fund the purchase with a different payment method such as Wal-Mart credit account. If customers can be conditioned to use their app for payment, it would be an easier sale to encourage them to switch to using a different payment method within the app.
Using Yahoo's data (from Capital IQ), the historical operating margin is running 5.25% for Wal-Mart. If those margins were improved by even .25%, it would be an almost 5% increase in EPS.
Conclusion
So far, Wal-Mart is simply announcing that they are moving on rather than wasting time waiting for the "payment solution" that doesn't meet their customer's needs. Because their system still uses credit cards and protects the customer, this app is surpassing some of the major issues of the Merchant Customer Exchange program. However, the inclusions of credit cards as a source of payment limit the expected direct impact that this system could have for Wal-Mart's margins.
Overall, I'm expecting most customers to continue using their credit cards. However, if Wal-Mart is able to gain even a small reduction in fraud issues with this technology it could be positive for Wal-Mart, Visa, and MasterCard
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