Global retailing powerhouse Wal-Mart (WMT) reported soft results for its fiscal year 2014 second quarter. Total sales increased 2.4% year-over-year to $116 billion, slightly below consensus expectations. Earnings-per-share was in-line with consensus estimates, increasing 5.1% year-over-year to $1.24. Year-to-date, Wal-Mart has generated $5.2 billion in free cash flow, equal to 2% of total revenue.
Though headline results could have been worse, we were disappointed to see performance in the US remain negative, as same-store sales declined 0.3% year-over-year. Management noted on its second-quarter prepared remarks that traffic improved sequentially and that some softness was due to the firm's investment in price. Operating margins actually increased 20 basis points year-over-year to 8% of sales, suggesting the firm is experiencing some nice fixed cost leveraging. The firm's US results were weaker during the first quarter, so while we were disappointed, its core US business might be improving, albeit modestly.
Sam's Club was a slightly-more-positive story, with same-store sales up 1.7% compared to the year-ago period. Fuel sales had no impact on the number, and several of Sam's Club segments posted healthy results. To no surprise, electronics registered a negative comparable growth rate, and the segment experienced soft beverage sales in light of a relatively cool (weather) quarter. Management offered some bullish commentary on the broader economy, as Sam's Club CEO Rosalind Brewer noted on the call:
"Small business owners report through our monthly Small Business Owner study that they are more optimistic about the upcoming months and perceive that the current economic climate is gradually improving. We believe their businesses are beginning to show signs of recovery, as evidenced by the improved traffic trends."
Since the Great Recession, we've seen management teams across all sectors use the "challenging" economy as an excuse. With the consensus slowly turning, we think the executive suite will no longer have a valid excuse for poor execution.
International results weren't that impressive as total sales increased just 2.9% year-over-year, to $32.9 billion. Segment operating income was 1.3% lower than a year ago at $1.5 billion, reflecting weaker operating margins and a lack of cost leveraging. Though management listed some other factors, including strategic investments and higher indirect taxes, the clear issue internationally continues to be on the labor side of the equation. Wal-Mart's International President and CEO Doug McMillon painted the picture of a story we've heard a few times, saying:
"In many of our International markets, labor laws and employment contracts mean it takes more time and is more complicated to introduce and implement productivity improvements that can help us adjust labor costs to sales trends. While our core expense story has improved, we expect third quarter expenses to be under pressure, also due to the same factors I just mentioned."
McMillon noted that labor man-hours declined 12.4% sequentially in China thanks to improved operations, and we suspect Wal-Mart will continue to be focused on boosting operating margins in coming quarters.
Looking ahead, Wal-Mart ratcheted down its full-year sales expectations to 2-3% sales growth (was 5-6% sales growth) and cut its full-year earnings per share outlook to $5.10-$5.30 (was $5.20-$5.40). Though we never like to see a guidance cut, we don't believe the cut is steep enough to warrant a fundamental change in thinking about Wal-Mart's success.
Fiscal second-quarter results and full-year guidance were both relatively poor at Wal-Mart, but we believe management remains intensely-focused on reducing fixed costs and growing gross-margin dollars, wherever possible. Wal-Mart's free cash flow was down just slightly compared to the year-ago period, and broader economic growth could help Wal-Mart's business accelerate. US results weren't great, but it seems as though the impact of the payroll tax increase could be temporary. Nevertheless, we continue to believe shares of Wal-Mart look fairly valued, and we see no compelling reason to add them to either of our actively-managed portfolios.