The world's largest retailer, Wal-Mart (WMT - Free Wal-Mart Analyst Report), posted July-quarter results that were in line with guidance and expectations. Net sales rose 2.8%, year over year, to $119.3 billion, while earnings per share of $1.21 were once cent above our estimate.
Consolidated operating income fell 50 basis points, as U.S. employee healthcare costs were up $180 million due to higher enrollment and inflation. The full-year number is expected to be $500 million more than last year, which is reflected in earnings guidance. Additionally, higher labor costs are also hurting profitability, as the company appears to be figuring out how many work hours it needs to keep shelves stocked and customers happy while still being able to “invest” in everyday low prices. Encouragingly, Wal-Mart International's operating income rose 8%, as most markets leveraged expenses and the company capitalized on some tax matters. Overall, the aforementioned headwinds, combined with greater preopening expenses for the Neighborhood Market footprint expansion (more below), should restrict companywide operating profit growth in coming quarters.
As expected, the company's largest and most important division, Wal-Mart U.S., delivered flat same-store sales in the quarter. Supercenters had a comp decline of 30 basis points. Management was not pleased with this result and looks to gain an edge with innovative mobile-based promotional tactics like its Savings Catcher price-match program, continued focus on everyday low prices, merchandise selections that cater more to local tastes, and a new opening price point private label line, Price First, which will arrive late in the current quarter. We think these tactics will help move the needle, but may not be enough to fully offset reserved spending by Wal-Mart's cash-strapped and increasingly bargain savvy core customer base of low- and middle-income consumers.
Taking a more granular look into results at U.S. locations, inflation was up 60 basis points from the first quarter, to approximately 1.8%. Food sales were flat as the company continues to absorb some of the cost increases to stay competitive on high volume goods that drive traffic, while also passing some of the burden onto the consumer by raising prices on categories such as deli, dairy, produce, meat, and seafood. The company pointed out that sales are still being hindered by cuts to the Supplemental Nutrition Assistance Program (SNAP), a.k.a food stamps. The effect of this change will be anniversaried in November, but should continue hurting sales comparisons in the meantime.
Consumables, general merchandise, and hardlines are being hurt by “industry softness” which is leading to negative comps. We are inclined to believe this is the result of consumers' unwillingness to spend rather than Wal-Mart's merchandise or competitive strategies. Health & wellness continues to be a standout thanks largely to affordable prescription drugs. Apparel sales were up in the low single-digits owing to national brands and effective merchandise sourcing. Overall, domestic sales (includes stores that have been open for less than one year) increased 2.7%.
Although big box supercenter openings over the past year explain most of the discrepancy between comps and total sales, the rollout and performance of small format Neighborhood Market stores is also starting to contribute. Indeed, comps there rose 5.6%, with traffic accounting for 4.1% and the rest stemming from a higher average transaction amount. Product categories that exhibited the most strength were pharmacy, produce, meat, and adult beverages. This makes sense considering the store format's goal is to capture demand for goods that are replenished frequently and that customers don't necessarily want to travel to a supercenter to buy.
Importantly, WMT remained on track to open 180 to 200 Neighborhood Markets this year, a large number of which will start operating in January of 2015. The rollout of even smaller format locations reserved for urban centers, dubbed Wal-Mart Express stores, should also help sales, but to a lesser degree, as the concept is still being tested. We like the small-format strategy and think it will help WMT to compete better with grocery stores, dollar stores, and even Web-based outfits that are offering an increasing number of day-to-day items once reserved for physical retail outlets.
Sam's Club stores performed about the same as Wal-Mart's supercenters, delivering flat comps. However, membership income was up 11.9%, driven largely by renewals and upgrades to its premium Plus membership as last year's fee increase is no longer a factor in comparative data.
International sales grew 3.1% (5.3% in constant currency terms), to $33.9 billion or 28% of the total. The company is making progress implementing its everyday low price strategy overseas. Comp sales were positive everywhere but China. Specifically, Argentina, Chile, Japan, and Africa did particularly well.
Finally, global e-commerce sales rose 24% thanks partly to double-digit gains in the U.S., U.K., China, and Brazil.
Although, there were some bright spots in the quarter, underlying U.S. demand remains stagnant due to the challenging retail environment, and we expect comps to remain flat. This, combined with inflated healthcare costs, more labor hours, e-commerce investment, and higher preopening expenses prompted the company to lower its earnings guidance to a range of $4.90 to $5.15, from the prior range of $5.10 to $5.45, a 4.7% decrease at the midpoints. In response, we are lowering our full-year earnings estimate to $5.00 from the previous $5.15. Despite the headwinds, we still like these shares, based largely on footprint expansion opportunities, the company's compelling value proposition, and innovative integration of its digital and physical retail experiences.
About The Company: Wal-Mart Stores, Inc. is the world’s largest retailer, operating 3,288 supercenters (includes sizable grocery departments), 508 discount stores, 632 Sam’s Clubs, and 407 Neighborhood Markets in the U.S., plus 6,107 foreign stores (mainly in Latin America, with the balance in Asia, Canada, and the U.K.) for total square footage of 1.101 billion (as of 1/31/14). Most stores are owned and are within 400 miles of an expanding network of distribution centers. Groceries accounted for 55% U.S. sales, while sales per square foot were about $437.