Wal-Mart Cuts Guidance On Weak Traffic, Higher Expenses And Slow Online Growth

Following five consecutive quarters of comparable sales decline, Wal-Mart‘s (NYSE:WMT) results disappointed once again as it posted flat comparable sales growth for Q2 fiscal 2015. Driven by a consistent decline in store traffic, along with cautious consumer behavior, Wal-Mart barely matched its last year’s sales figures. The company’s earnings per share increased by just 0.6% as its profits were dented by higher healthcare costs. Following these results, Wal-Mart slashed its full year EPS guidance from $5.10-$5.45 to $4.90-$5.15 as it expects healthcare expenses, compliance costs, an increase in labor hours and e-commerce investments to weigh on its profits. ^[1]

Wal-Mart’s results confirmed that U.S. buyers are still not spending freely. Moreover, they are preferring online shopping over store shopping to avoid impulse buying. When shopping online, buyers usually stick to their shopping list. While this trend has hurt consumer spending at Wal-Mart, it has helped online sales of retail giants. During the quarter, Wal-Mart’s e-commerce business performed reasonably well, adding about 30 basis points to its U.S. comparable sales growth with double-digit rise in revenues. However, this growth was slower than the company’s initial forecast of 30% growth for the year, which it has now revised to mid-20s. Nevertheless, Wal-Mart is trying hard to bolster its online channel to make it a valuable contributor in the future.

Interestingly, Wal-Mart did not alter its small store expansion plans in the U.S. despite proposed Dollar Tree-Family Dollar merger emerging as a formidable threat. While the company believes that it is well positioned in terms of its small store expansion plans, we think that it needs to extend its reach at a faster pace, or else, dollar chains will continue to nibble into its market share.

Our price estimate for Wal-Mart stands at $79.30, which is more than 5% ahead of the market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Wal-Mart

Higher Expenses to Dent Wal-Mart’s Profits

Wal-Mart’s healthcare expenses are increasing rapidly driven by growing employee signups for health coverage. During the second quarter, healthcare expenses increased by a sizable $180 million, which was well above the company’s expectations. Wal-Mart expects this to continue for the remainder of the year on account of higher costs related to providing benefits and increased employee enrollment. The retailer initially anticipated an increase of $330 million in healthcare expenses for the second half of the year, but it now expects the expenses to increase by $500 million.

During the quarter, Wal-Mart continued to spend on issues related to alleged anti-bribery law violations and changes in global compliance program. It even increased work hours for front-end employees, bakery workers and overnight stockers, that expanded its wage-related expenses by $200 million as compared to last year. With U.S. consumers purchasing more online, Wal-Mart has decided to ramp up its investments in this arena. The company stated that it will spend an additional 5 cents – 7 cents per share this year instead of 2 cents – 4 cents, to revamp its e-commerce infrastructure. ^[2] Citing these expenses as the main reason, the company lowered its EPS guidance for the year by $0.20-$0.30.

E-Commerce Growth will be Slower-than-Expected

In a shareholder meeting held earlier this year, Wal-Mart stated that it expects its e-commerce sales to increase by about 30% in fiscal 2015. ^[3] This appeared an achievable target as the company reported 27% growth in its online sales in the first quarter of fiscal 2015. However, the retailer has now lowered its e-commerce growth guidance from 30% to mid-20s, on account of slower-than-expected growth in Q2. During the quarter, Wal-Mart’s e-commerce revenues increased by just 24%, which was weaker than its expectations. ^[1]

Given that U.S. buyers are gradually shifting to online shopping, developing its web presence should be among Wal-Mart’s top priorities. The company is looking to develop its omni-channel platform with services such as pay-with-cash, which can help it address its low store traffic problem by leveraging buyers’ interest in online shopping. The retail giant is also trying to sell groceries online and increase its delivery effectiveness to present a better challenge to Amazon (NASDAQ:AMZN). We believe that with effective strategy execution, Wal-Mart will be able to grow its e-commerce channel into a sizable business in the long run. However, expected slowdown in online revenue growth in fiscal 2015 can have a marginal negative impact on investor confidence in the company.

Small Store Plans Remain Unchanged

The proposed merger between the Dollar Tree and Family Dollar will create a massive retail chain of 13,000 stores targeting Wal-Mart’s customer base. It thus might be expected that Wal-Mart would look to energize its own small store expansion plans. However, the company opened just 22 Neighborhood Market stores in the second quarter and stuck to its initial plan of opening 180-200 Neighborhood stores and 90-100 Express stores in fiscal 2015. For some time now, U.S. buyers have been preferring conveniently located stores within the city over traditional Wal-Mart stores located on the outskirts. As a result, traffic and comparable sales at the retailer’s small stores have been increasing consistently. During the second quarter, comparable sales at Neighborhood stores increased by 5.1% and traffic increased by over 4% across all the small formats. ^[4]

The company believes that it is well positioned in urban markets despite heightened competition from the dollar chains. However, Wal-Mart has a negligible small store presence as compared to dollar chains, who cumulatively operate over 20,000 stores. Although the retailer’s expansion pace is fast, it no longer has the option to acquire Family Dollar. Hence, it will be a while before Wal-Mart has a small store presence comparable to dollar chains. Until then, they will remain a concern for the retail giant.

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1. Walmart Reports FY 15 Q2 EPS of $1.21, Walmart, Aug 14 2014 [↩] [↩]
2. Health Costs, Weak Store Traffic Hinder Wal-Mart, The Wall Street Journal, Aug 14 2014 [↩]
3. Highlights from Wal-Mart’s Shareholder Meeting, Seekingalpha, Jun 6 2014 [↩]
4. Walmart squeezes out small profit in Q2, USA Today, Aug 14 2014 [↩]