Wal-Mart (WMT), the giant of retail mass merchants, reports fiscal Q3 2014 financial results before the bell on Thursday morning, 11/14.
Analyst consensus (per ThomsonReuters) is expecting $1.13 in earnings per share on $116.79 billion in revenue for expected year-over-year growth of 4% and 3%, respectively.
Since the August 2013 report, consensus EPS estimates have fallen $0.02 per share and the consensus revenue estimate has fallen about $800 million from the $117.60 billion original estimate.
Last quarter, WMT had a pretty ugly report and guided lower for Q3 2014 based on poor US grocery (about 50% of sales currently), poor entertainment comps (made me think of the resurgent Best Buy) and a weak International segment, which saw revenue growth of 4%, but operating income growth of 2%.
As this Seeking Alpha article details, we think the stock represented good value in the low $70s in mid-September and added some after the tough 3rd quarter.
Short-term, you would think that the drop in the price of gasoline would help WMT given its demographic, but longer-term the continued subdued rate of inflation and even disinflation in the US economy has to be hurting WMT's ability to maintain margins and sustain its "Every Day Low Price" (EDLP) mantra.
I can't recall the source of the article but it was another contributor, and this writer did mention that the continued disinflation in the US had to be impacting WMT's ability to operate at a peak level, and it was a very astute observation.
Hyper-inflation (think pre World War II Germany) is a horrific economic environment because it grossly over-stimulates consumption and borrowing and penalizes saving, while deflation like we also saw in the US during the Great Depression is also quite ugly, but these represent the two price extremes.
In the US today, and what the Fed continues to combat with ZIRP (zero interest rate policy) is disinflation, or the slow, general, decline or softening in the rate of inflation or general price levels brought on by lack of spending and the collapse of asset prices following the fall of 2008.
Here are two excellent articles by Doug Short (one here) which compares the core CPI with the core PCE (note the level of the Core PCE, which to me looks to be in the area of 1% - 1.5%) and here, which is Doug's first article from early June 2013.
When you think about it, it makes sense: WMT is expected to generate $500 billion in annual sales in fiscal 2015 (ends January 2015), which makes WMT the largest retailer in the US. However, its EDLP mantra does not come to fruition from simply selling its store products at EDLPs. WMT has to generate its ability to sell at the lowest prices every day by merchandising and astute purchasing, and with even just a little inflation or rather an increase in inflationary expectations, WMT should be able to sustain gross and operating margins, and even increase those margins with better flexibility around pricing.
It seems to me, (and this is just a personal opinion) that a benign pricing environment and a disinflationary economy is presenting a challenging economy within which WMT is currently operating, although the retailer is still managing to generate low-single-digit revenue growth and high-single-digit EOS growth in today's economy.
That being said though, WMT has managed to maintain its gross margin in the 24% - 26% range and operating margin in the 5% range, despite the weak US economy and a stretched demographic.
Valuation: With current consensus EPS of $5.20 and $5.70 for fiscal 2014 and 2015, WMT is trading at 15(x) and 14(x) forward estimates for expected growth this year and next of 7% and 10%. Revenue growth the next 2 years is currently expected at 3% and 4%, respectively.
The forward EPS estimates continue to be revised lower, so there remains downward pressure on the 2014 and 2015 estimates.
At 10(x) 4-quarter trailing cash-flow and 21(x) free-cash-flow, WMT is not really cheap on a cash-flow basis either, which is our preferred method of valuation.
Our internal model values WMT at $85 per share, which gives a premium to the stability and consistency of earnings growth, while Morningstar's discounted cash-flow model values WMT at $74 per share.
Technically: WMT has been locked in a trading range between the May '13 high of $79.96 and the early October '13 low of $71.51. WMT hit its previous all-time high of $70.25 in the first week of January 2000, which it didn't then trade above until July 2012, and since that time, WMT has managed to stay above that January 2000 high.
The fundamental improvement, which corresponded with the July 2002 breakout, was an improvement in US store comps, which hit +2.6%, but have since slid back into the negative comp range.
WMT has traded back to the high end of its range.
Summary: the potential positives around this quarter are the declining price of gasoline, which could help US comps, an improved apparel comp, stronger employment data and a falling unemployment rate, better economic growth, a lapping of the Sandy and Nemo superstorms in the Northeast over the next two quarters, and an improved consumer.
What we worry about is the WMT demographic, and the impact of the Affordable Care Act, the tepid economic growth, and the law of large numbers around growing a $500 billion retailer every year.
WMT has missed revenue estimates 6 of the last 7 quarters, which gives you some idea of the operating and consumer environment within which WMT operates.
The best macro catalyst for such a large broad-line retailer in our opinion would be stronger GDP growth (a string of quarters north of 3%) and an acceleration in inflation, rather than the slow drip of disinflation that is being seen currently. (Some might actually argue that WMT is a contributor to the slow US disinflation rate, rather than a victim of it, but if that were the case, I think revenue growth would be a little stronger.)
WMT needs a little pricing power to complement its unsurpassed ability to merchandise store products.
Here is a brief table of WMT's recent history in terms of key metrics:
WMT is one of our favorite success stories, when looking at the post WW II US economy. To think that one guy, Sam Walton, started one retailer that will generate $500 billion in revenues (expected in fiscal 2015).
A breakout above $80 on volume, and the stock will run again. Expectations are subdued, coming into the 3rd quarter report (a positive) but the Christmas holiday guidance will be very important.