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Wal-Mart Stores, Inc. (WMT) Earnings Update

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Wal-Mart Stores, Inc. (WMT) Earnings Update Earnings Update by Sure Dividend

Wal-Mart Stores recently released its 2nd quarter results.

The market viewed the results unfavorably; Wal-Mart stock dropped 3.4% the day of the earnings release – making Wal-Mart even more undervalued.

Here’s what went wrong – Wal-Mart reduced its guidance for full fiscal 2016 (Wal-Mart’s year ends in January) from a range of $4.70 – $5.05 to a range of $4.40 – $4.70.

The guidance decline sounds bad (and it certainly isn’t good), but Wal-Mart’s quarter was better overall than the market indicated.

The good news is that new initiatives are driving comparable store sales increases in the United States. Unfortunately, margins are being compressed as the cost of Wal-Mart’s initiatives in the short-run is more than short-run gains.

‘Initiatives’ is a rather nebulous term. What initiatives, exactly, does Wal-Mart have? Wal-Mart is repositioning itself for the future by investing in e-commerce and better rewarding its employees in an attempt to provide better service for customers.

Both of these initiatives should provide long-term benefits. Greater e-commerce business and connectivity with brick-and-mortar stores makes for a better shopping experience – which drives sales. More motivated employees make for a better shopping experience – which also drives sales.

New Fulfillment Centers

Wal-Mart will open a total of 4 new automated fulfillment centers this quarter. The quote below by Wal-Mart Global e-Commerce president Neil Ashe from the company’s conference call explains these new upgrades:

“We opened two new automated online fulfillment centers, each bigger than 20 football fields, and we have two more coming this quarter. These fulfillment centers are strategically located across geographies and will begin to serve our customers this holiday. They will be cornerstones of our fulfillment network going forward.”

Investments in these fulfillment centers will help to increase profits by reducing distribution costs. Wal-Mart CEO Doug McMillon had this to say about the new fulfillment centers:

“When all of our e-commerce fulfillment investments come online, we expect them to lower our distribution costs in the mid-term, starting in the fourth quarter and having a larger, positive impact next year.”

Wal-Mart has long been recognized as an innovator in logistics. The company’s new fulfillment centers will help the company to further increase its supply chain efficiency.

E-Commerce Operations

Wal-Mart’s e-commerce sales grew 16% in its most recent quarter versus the same quarter a year ago.

The company’s strong growth in e-commerce is a positive sign for shareholders. Wal-Mart started targeted testing of an unlimited free shipping program priced at $50 per year last quarter. Think of it as a competitor to Amazon’s Prime service.

Despite 16% growth, Wal-Mart is not living up to its forecasted e-commerce growth. U.S. e-commerce sales are growing as expected, but international sales are weaker-than-expected. Weak international e-commerce sales caused Wal-Mart to lower its full year e-commerce growth guidance from 20% to the mid-to-high teens.

Rising United States Sales

Wal-Mart posted positive comparable store sales of 1.5% and total sales growth of 4.8% in its United States segment.

The company operated more efficiently as well; comparable store inventory declined 2.4%.

E-commerce sales contributed 0.2 percentage points to comparable store sales growth in the most recent quarter.

Neighborhood market stores grew comparable store sales 7.3% – continuing the trend of solid growth in Wal-Mart’s smaller store layouts.

Sales Rise, But Operating Income Declines

Positive comparable store sales is a good sign. It shows that Wal-Mart’s initiatives are working to drive higher sales – which is what they should do.

Unfortunately, operating income declined significantly for Wal-Mart’s United States segment; down 8.2% in the company’s most recent quarter. Wal-Mart U.S. president Greg Foran had this to say about the declines:

“Three major factors contributed to our underperformance: a decline in gross margin, primarily related to lower than expected pharmacy reimbursements and accelerating pressures in shrink, as well as a higher than planned investment in store hours which was essential to improving the customer experience.”

Wal-Mart is not alone in pharmacy reimbursement profit declines. Since the battle between Walgreens (WBA) and Express Scripts (ESRX), pharmacy benefit managers have been ‘tightening the screws’ on retailers. This trend will likely continue. Pharmacy benefit managers know retailers need to provide pharmacy services to entice customers into their store to buy other items. If they don’t, these customers may shop elsewhere.

The ‘shrink’ mentioned in the quote above is disappearing inventory. This can happen either through accounting errors or through theft. It is disturbing to see Wal-Mart have issues with shrink while it is simultaneously raising employee raises. If shrink is from internal theft, theft by customer, or accounting errors, it doesn’t matter – ultimately Wal-Mart’s employees are performing worse (at least on shrink), while being paid more.

Updated Guidance

Despite continued issues, Wal-Mart is expecting 1% to 2% comparable store sales increases in its next quarter.

As mentioned earlier, Wal-Mart lowered its full fiscal 2016 guidance from a range of $4.70 – $5.05 to $4.40 – $4.70. . Additional expected costs that caused the guidance decline are shown below:

  • $0.02 from additional negative currency headwinds
  • $0.04 from additional wages, training, and hours
  • $0.11 from additional pharmacy declines and shrink

Obviously, Wal-Mart has no control over currency headwinds – that should not count against the company. The remaining $0.15 per share of earnings declines are a result of management’s inability to accurately forecast its business and manage effectively.

Additional wage costs AND increased shrinkage are especially troubling. If you a higher number of employees more money, you should not get worse results.

Final Thoughts

If you focus on Wal-Mart’s myriad issues, the company looks troubled. Taking a big picture view, Wal-Mart is still the largest and most profitable retailer in the world.

The company’s investments in infrastructure and e-commerce will likely pay long-term dividends. Wal-Mart continues to struggle with employee relations and inventory control. Despite this, the company is growing comparable store sales in the United States.

Wal-Mart’s short-term headwinds obfuscate its favorable long-term prospects.

The stock currently has a 2.9% dividend yield and a price-to-earnings ratio of just 14.2. The market is focusing on the negatives of the company which has made Wal-Mart undervalued. Wal-Mart is currently a favorite of The 8 Rules of Dividend Investing due to its above-average yield, stability, and favorable valuation.

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