Wal-Mart Earnings Preview: Consistent Decline In Foot Traffic And Higher Expenses Will Subdue Results

When the retail giant Wal-Mart (NYSE:WMT) comes out its Q3 fiscal 2015 earnings on November 13th, its growth is unlikely to be any different from what it has been in the past several quarters. The company hasn’t seen positive comparable sales growth for almost six quarters now and to make things worse, it slashed its full year sales growth guidance last month from 5% to just 2%-3%. ^[1] While overall retail sales in the U.S. have improved at a moderate pace during the third quarter, a decline in store traffic and Wal-Mart’s weakness in the online channel would have made it difficult for the retailer to match the industry growth levels. We believe that apart from its topline growth, Wal-Mart’s bottomline growth might have also struggled during the quarter owing to certain increased expenses.

Also, during its last quarterly earnings call, Wal-Mart had stated that its online sales have grown at a slower-than-expected pace, despite the shift in U.S. buyers’ shopping preferences. In the wake of slowing online growth, the company had reduced its e-commerce growth forecast for the full year from 30% to mid-20s, at the end of Q2. While online channel likely did little boost to Wal-Mart’s growth in the quarter, it offers a key path to higher growth for the company.  In an update last month, Wal-Mart had stated that it will increase its investments in e-commerce by close to 50% next year. ^[1]

Our price estimate for Wal-Mart stands at $80, which is just ahead of the current market price.

See our complete analysis for Wal-Mart

Retail Environment in Q3 Looked Good

After a slump in the first three months of 2014, U.S. retail sales improved in the second quarter primarily driven by pent-up demand. The positive trend continued in August 2014, as retail sales excluding automobile and gasoline sales increased by 0.5% from the previous month and almost 5% year over year. ^[2] Lower gasoline prices and better employment trends drove consumer confidence higher, that ultimately uplifted retail sales. Unemployment rate fell to just 6.1% in August 2014 from 7.2% in the same period last year. ^[3] In September, although retail sales declined at a greater-than-expected rate of 0.3% from August, they were 4.3% above September 2013’s levels. ^[4] Sentiment continued to improve during the month as unemployment rate fell to a five-year low of 5.9%. According to Redbook Research’s sales index, seasonally adjusted retail sales in October increased 4% year over year driven by strong sales during the fourth week supported by Halloween. ^[5] Overall, the third quarter of 2014 (August-October) looked good for the U.S. retail market, but buyers continued to shift from store shopping to online shopping.

However, Traffic Decline would have Troubled Wal-Mart

Although U.S. retail sales are growing at a decent pace, store traffic across the industry is falling. According to ShopperTrak, a firm that tracks store traffic in over 40,000 outlets across the U.S., store visits have fallen consistently by close to 5% year over year in all the months of the past two years, barring April 2014. Even in August, 4.7% fewer shoppers went out for shopping as compared to the previous month. ^[6] To better understand the intensity to traffic decline, it is worth noting that store traffic in September 2014 was 17% below what it was in the same month last year. ^[7] The consistent decline in store traffic is attributable to buyers’ increasing interest in online shopping. While overall retail sales are growing with this steady shift from physical to digital shopping, retailers such as Wal-Mart, Target (NYSE:TGT) and Bed Bath & Beyond (NASDAQ:BBBY), who rely on store sales for more than 95% of their revenues, are faltering. Therefore, we believe that Wal-Mart is unlikely to report positive comparable sales growth in Q3, with significantly fewer shoppers as compared to last year.

Higher Expenses can hurt Profits

Wal-Mart’s healthcare expenses are increasing at a rapid pace driven by growing employee signups for health coverage. During the second quarter of 2014, healthcare expenses increased by a sizable $180 million, which was well above the company’s expectations. Wal-Mart had said during its Q2 earnings release that it 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 stated that while it initially anticipated an increase of $330 million in healthcare expenses for the second half of the year, the increase may now be close to $500 million. ^[8] This indicates that Wal-Mart’s healthcare expenses for the third quarter would have been on the higher side, which is not a good news for its bottomline growth.

Moreover, Wal-Mart had decided to ramp up its investments in the online arena at the end of the second quarter. 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. ^[9] With increased investments, it had lowered its EPS guidance for the year by $0.20-$0.30, a part of which will be reflected in Q3 results.

Online Channel in Focus

With U.S. buyers increasingly switching to online shopping and the retail industry gradually adopting an omni-channel model, it is evident that Wal-Mart will look to employ several strategies to bolster its own web platform. While the company’s online sales growth this year hasn’t matched its expectations, the channel still holds tremendous long-term potential and it makes sense for the company to continue investing in it. Last month, the company stated that is planning to slowdown its store expansion, but intends to increase its investments in e-commerce. Wal-Mart had said that it will invest close to $1.5 billion in e-commerce projects next year, 50% more than what it plans to do this year. ^[1] We are eagerly waiting for the earnings call to identify the areas, where the retailer will look to uplift its investments.

To bolster its comparable sales growth, Wal-Mart needs to have a sound e-commerce platform, for which its has to take giant strides. E-commerce retail industry is going through a tremendous growth phase, and the retail giant should make the most of it. It is likely that sometime in the future, online retailing’s honeymoon period will come to an end. Wal-Mart needs to transform its e-commerce channel into a significant revenue contributor long before that happens.

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1. Wal-Mart Cuts Annual Sales Forecast As Supercenters Struggle, Bloomberg, Oct 17 2014 [↩] [↩] [↩]
2. U.S. Retail Sales Rose 0.6% in August, The Wall Street Journal, Sept 12 2014 [↩]
3. Labor Force Statistics from the Current Population Survey, Bureau of Labor Statistics, Nov 7 2014 [↩]
4. U.S. Census Bureau News, Oct 15 2014 [↩]
5. U.S. Retail Sales Rise in October from September – Redbook, Nasdaq, Nov 4 2014 [↩]
6. Back-To-School Slump Raises Concerns About The Holiday Season, Bloomberg, Sept 23 2014 [↩]
7. U.S. Retail Benchmarks Show Decline in Store Traffic, Business Solution, Oct 21 2014 [↩]
8. Walmart Reports FY 15 Q2 EPS of $1.21, Walmart, Aug 14 2014 [↩]
9. Health Costs, Weak Store Traffic Hinder Wal-Mart, The Wall Street Journal, Aug 14 2014 [↩]