Finally Some Good News For Wal-Mart – Seeking Alpha

More than two years ago, in January 2013, Bill Simon announced the intention of Wal-Mart (NYSE:WMT) to source more from domestic suppliers. WMT wants to grow what the company already purchases domestically in categories such as sporting goods, apparel, storage bins, and paper products. More ambitiously, the company also wants to encourage the onshoring of U.S. production in departments which it traditionally imports, such as textiles, furniture, and high-end appliances.

For a long time, Wal-Mart was known as the company that moved manufacturing jobs away from America and to countries such as China because of its purchase of foreign products. But the giant retailer is trying to change the narrative. As recently as July 7, 2015, the company reaffirmed its commitment to bring back jobs and manufacturing to the United States by hosting a manufacturing summit for domestic factories in its headquarters in Bentonville, Arkansas.

From “Made in China” to “Made in USA”

Wal-Mart had publicly committed to buying $250 billion worth of goods from domestic sources by 2023. The company claimed that buying more “Made in America” products is good for the business. Labor costs in China is now about 61% that of the U.S., up from around 17% some 15 years ago. Harold Sirkin of the Boston Consulting Group described the manufacturing cost pendulum as swinging back in favor of the U.S. in recent years. But he also warned that the pendulum could easily swing back the other way against the U.S.

The buy American campaign initially appeared to be a winning formula for Wal-Mart. After all, eight of ten Americans told Consumer Reports they would rather buy a product made in the U.S. than one made outside the country. So buying more domestically should be good for the business because stateside manufacturing cost is now relatively inexpensive. It would also provide a sales boost because of shifting consumer preference for products made in the country.

Are Products Really Made in USA?

However, as with every piece of good news associated with Wal-Mart in recent years, the strategy quickly backfired. Apparently, some of the products claimed to be “Made in USA” on the website turned out to contain packaging and labels on the product that stated they were “Made in China.” Wal-Mart explained that these products were previously made in China but now stateside, but the labels were not yet updated.

Other critics dismissed the Wal-Mart onshoring effort was too little too late. The critics estimated that the buy-American campaign had only generated 2,000 new jobs in the last two years, a far cry from the 3.2 million manufacturing jobs lost because of the trade imbalance with China since 2001.

Critics pointed to the case of Element Electronics as an example of the window dressing they believed Wal-Mart did. Element-branded televisions were publicly celebrated and labeled as American-made. But the reality was that the televisions were mostly assembled in China before being shipped in boxes to South Carolina. The workers in South Carolina merely added a memory board and checked for defects before placing the product back in the box.

Another difficulty of the buy American campaign was that after decades of declining manufacturing activity in the U.S., domestic companies trying to restart manufacturing were faced with the twin challenges of a shallow pool of domestic component suppliers and lack of skilled workers in specialized manufacturing operations. CEO H. Kim Kelly of Hampton Products, maker of locks and lighting, explained that “a lot of the tribal knowledge and skill sets are gone because the humans who used to do that work have either retired or died.”

Pendulum Swings Again

Concerned that its exports were slowing and its economy underperforming, China devalued its currency in August 10, setting off a firestorm in currency and stock markets around the world. Opinions are divided, but I believe this is simply the beginning of a new long-term decline for the Chinese currency, reversing the decade long appreciation of the Chinese currency by 33% against the US dollar since 2005.

It is possible that the Chinese currency will backtrack from around 6.2 before the devaluation August 10 back to its original peg of 8.28 in 2005. Even if the yuan does not return to its previous value of 8.28, any substantial weakening against the US dollar would likely put tremendous pressure on Wal-Mart’s already troubled effort to increase domestic sourcing.

Imports Could be Back in Fashion For Wal-Mart

The buy American campaign would face more pressure in the next year or two. With the weakening yuan, Wal-Mart buyers could put pressure on suppliers in China to lower invoices mostly denominated in US currency. What happens next depends on the level of political pressure imposed on the all-important buyers of hardline and softline goods. Food and grocery items are already mostly sourced domestically and are not critical in this analysis.

If buyers are not constraint by the need to increase sourcing from U.S. factories, Wal-Mart would be able to invest more in lower prices and maintain its core reputation as an Every Day Low Price retailer. Sales and margins would quickly improve and investors would be rewarded. But if Wal-Mart buyers are pressured to achieve the increasingly unrealistic goal of sourcing $250 billion from U.S. factories, sales and margins would suffer and investors would be punished.

My opinion is that Wal-Mart top management would quietly drop the politically-correct idea of buying more domestic products and encourage front-line buyers and sourcing professional to take advantage of the lowered Chinese currency to press for even more cost reductions from suppliers. With its unmatched volumes and purchasing power, which even Amazon (NASDAQ:AMZN) could not match because it is purchasing at least four times less, Wal-Mart could easily buy at even lower prices than all its competitors.

Implication for Investors

For the long-suffering WMT investor, the decline of the Chinese currency could among the best news this year. Wal-Mart could turn out to be one of the biggest beneficiaries of China’s decision to devalue the yuan.