Wal-Mart’s Missed Earnings Signal A Bleak 2015

Retail giant Wal-Mart (NYSE:WMT) missed consensus estimates with its Q1 fiscal 2016 release, as revenues fell slightly and profits declined more-than-expected. The company reported net revenues of $114.8 billion, marginally below last year, and behind the market expectation of $116.3 billion. Its earnings per share came in at $1.03, trailing analysts’ estimates of $1.04 and down from $1.10 in the year ago period. ^[1] While Wal-Mart U.S.’ revenues grew moderately by 3.5%, international revenues stumbled 6.6% weighed down by strong dollar, which suppressed incoming revenues from international markets. Excluding the $3.3 billion negative impact of currency fluctuations, Wal-Mart’s international revenues increased 3.4% and overall revenues grew 2.7%. While the retailer’s topline growth struggled due to something that was beyond its control, its bottomline growth was subdued by its own decision. A while back, Wal-Mart had announced that it will be raising minimum wages for its employees. With the implementation of the new payment structure, its profits took a serious hit in Q1 fiscal 2016.

Looking ahead at Wal-Mart’s near future, aforementioned factors appear well on their way to trouble the company throughout the year. The dollar is expected to appreciate further against major currencies in 2015, and hence Wal-Mart’s steady growth in international markets won’t be turning into actual cash any time soon. The company has raised minimum wages for about half-a-million employees so far and hence, we can expect persistent pressure on Wal-Mart’s profits in the upcoming three-four quarters. In fact, the company plans to increase its minimum wage further from $9 to $10 by February 2016, which will add another significant amount to its SG&A expenses. ^[1] Another major factor that can trouble the company going forward is U.S. buyers’ persistent reluctance to spend freely despite their savings on fuel costs. It is almost certain that Wal-Mart’s topline growth this year will not be inline with the rise in its expenses and hence, its margins and profits will most likely shrink.

Our price estimate for Wal-Mart stands at $82, which is over 5% below the current market price.

See our complete analysis for Wal-Mart

The Following Will Remain A Drag On Topline Growth

Foot Traffic Decline: Foot traffic across the U.S. retail industry has been declining at a steady pace with buyers in numbers switching to online shopping. Along with other retailers who prominently rely in store sales for a bulk of their revenues, Wal-Mart has been at the receiving end of this trend. However surprisingly, traffic in Wal-Mart’s U.S. stores was up 1% in the first quarter, which the company attributed to good customer response to new assortments around spring and summer selling seasons. ^[2] Nevertheless, the massive scale of the retailer would not allow it to sustain this increase in store traffic, given that customers are moving in another direction. Hence, in the quarters to come, we expect store traffic at Wal-Mart to decline year-over-year or at most remain flat, which does not bode well for its comparable sales growth.

Weak Spending: Gasoline prices in the U.S. have fallen substantially over the last one year, which has had a positive impact on consumer affordability. Along with a fall in unemployment rate, this should encourage buyers to spend a little more freely on their discretionary as well as non-discretionary needs. However, this has not been the case. U.S. buyers definitely have a lot more in their wallets now, but they are choosing to pay their debts with the extra money rather than spending it at a retail store. Their impulse purchases have been somewhat replaced by money saving exercises, which isn’t doing much good for retailers.

Lower Food Prices: Wal-Mart mentioned in its earnings call that one of the biggest concerns in its grocery business was deflation in dairy and produce and only moderate inflation in meat. Though this was partially offset by inflation in certain categories, overall change in product prices for groceries remained negative. It even had a negative impact of 20 basis points on overall U.S. comparable sales growth. ^[2] There is a possibility that net deflation in groceries can continue in the coming quarters, which will weigh on the company’s overall sales growth given that it earns more that 50% of its revenues from groceries.

Strong Dollar: Dollar has appreciated significantly against other currencies over the last one year and it is likely sustain this momentum this year as well. Exchange rate analysts at BMO Capital believe that dollar can appreciate 5%-15% against other currencies in 2015. ^[3] While this signals the reclaimed strength in the U.S. economy, it is weighing heavily on companies that have a sizable portion of their business spread abroad. Wal-Mart earns close to 28% of its revenues from international markets and despite steady growth in constant currency, it has actually regressed in terms of reported revenues over the past five quarters. This may well continue in the coming three-four quarters.

Wage Hike Will Push Expenses Up

In February, America’s largest employer Wal-Mart announced that it will be raising minimum wagers to $9 an hour from the federal minimum of $7.25. The company had said that the 24% hike would impact 500,000 employees out of its 1.4 million employees in the U.S. ^[4] Wal-Mart believes that the additional amount it is paying its employees will encourage them to shop at Wal-Mart and the money will eventually come back to the company. This may happen in the long run, but the company is incurring significant additional expenses right now.

During the first quarter of fiscal 2016, Wal-Mart’s net operating income fell 8.3% as its SG&A expenses grew 2.8% mainly due to higher compensation paid as compared to last year. The retailer’s SG&A rate increased from 4.9% in Q1 fiscal 2015 to 5.4% in the same quarter this year. Given that Wal-Mart still has three quarters to go where it will be paying higher wages as compared to last year, it will most likely report similar figures for its bottomline. The company even plans to raise its minimum wages to $10 by February next year, which may well prolong its bottomline weakness.

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1. Profit slips at Walmart as revenue falls flat, The New York Times, May 19 2015 [↩] [↩]
2. Wal-Mart’s Q1 fiscal 2016 earnings transcript, May 19 2015 [↩] [↩]
3. Dollar Forecast to Rise 15 Pct in 2015 Say BMO Capital, PoundSterling Live, Jan 22 2015 [↩]
4. Wal-Mart Raising Wages as Market Gets Tighter, The Wall Street Journal, Feb 19 2015 [↩]