3 Reasons Why Wal-Mart Is In Trouble

Feb. 9.14 | About: Wal-Mart Stores, (WMT)

Wal-Mart (NYSE:WMT) increased earnings guidance by $0.10 at the end of Q3. Will it miss consensus estimates like it did in the first half of the year?

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Wal-Mart's Supercenters average approximately 182,000 square feet. Source: Wal-Mart

A little background
On the last earnings call Wal-Mart Stores' (NYSE: WMT) CFO announced an upward adjustment to EPS. Guidance was increased to a range between $5.11 and $5.21, up from $5.01 to $5.11. The company missed estimates in the first two quarters and beat by only $0.01 in the third, so where are executives expecting this $0.10 lift to come from?

The Q3 earnings report actually builds a better case for why the company should be decreasing guidance by $0.10, citing two events that will dilute earnings in the fourth quarter. The first is the sale of 50 under-performing stores in Brazil and China; the second is the end of a franchise agreement with Bharti Retail-Wal-Mart's wholesale leg in India. Together, they are expected to dilute earnings by $0.10, and yet the company wants to increase full year guidance by $0.10? I must be missing something.

In addition to the two events listed above, and according to the third quarter 10Q, there are several ongoing areas of concern for Wal-Mart: same stores sales are on the decline, operating expenses are growing faster than sales, and the company is facing several lawsuits for international bribery. Any one of these issues alone could challenge fourth quarter earnings.

Declining same-store-sales, increasing costs, and litigation
According to the third quarter earnings report, Wal-Mart increased sales by 1.6%, but same store sales declined by (0.2)%. The company blames the decline in sales on a host of issues that aren't going away in the fourth quarter, like "lower consumer spending primarily due to the slow recovery in general economic conditions, and the 2% increase in the 2013 payroll tax rate."

The sequester only exacerbates the issue. In 2013, $1 trillion in across-the-board government spending cuts were taken, which includes 1.3 million people cut off from emergency unemployment relief in December. This is a shared issue among big box retailers like Target (NYSE: TGT) and Big Lots (NYSE:BIG) -- both had poor same store sales growth in the third quarter. Like Wal-Mart, both companies attributed the decrease to a decline in traffic and consumer spending.

  • Target's same store sales growth was 0.9% in the third quarter of 2013, down from 2.9% in 2012. The company attributes the decline to a 1.3% decrease in the total number of transactions, and a 1.1% decrease in the number of units per transaction.
  • Big Lots' same store sales dropped 2.5% last quarter, driven by softness in hardlines, toys, small appliance, auto and electronics. The company expects the same trends to continue into the fourth quarter.

Another issue for Wal-Mart is that operating expenses are growing faster than sales, as expenses increased 2.2% in the first nine months of 2013. The company gives no reason for why that trend should end in the fourth quarter.

Wal-Mart is also under legal attack from multiple parties amid allegations of international bribery, but the one that can do the most harm is the United States Justice Department. Shareholders are also suing Wal-Mart and many of its employees, some of whom are no longer with the company. The investigation, which won the Pulitzer Prize, has been extended into China, India and Brazil. No estimate is given for the total impact of the lawsuit, but according to the third quarter 10Q, the company expects to pay between $50 to $75 million to cover compliance and training costs in the fourth quarter alone.

On January 31, the CFO of Wal-mart, the same guy that announced the $.10 increase in earnings guidance in the middle of November, said this in an official release:

For the full year, we expect underlying EPS to be at or slightly below the low end of our range of $5.11 to $5.21.

Well, this isn't a complete retreat, but at least Wal-mart is starting to see the light that was apparently blinding it during the last earnings call.

So, which one of the three issues mentioned above is causing this announcement?

As mentioned above, same store sales has been declining, and based on the last 14 weeks, it's still declining for two reasons as the CFO explains in the announcement: "First, the sales impact from the reduction in SNAP (the U.S. government Supplemental Nutrition Assistance Program) benefits that went into effect Nov. 1 is greater than we expected. And, second, eight named winter storms resulted in store closures that impacted traffic throughout the quarter."

Food stamps and bad weather did this to Wal-mart? Yes, but why did it raise EPS estimates in the first place? It's odd and it makes me question the logic of financial leadership -- the little hair of faith I was hanging on just snapped.

The Alpha bottom line
As an ex-financial analyst I can tell you that weather is a common catch-all category of explanations given by financial executives when the real answer is unknown.

The real answer is that Wal-mart had no idea how much of an impact cuts in government spending were going to have. According to the Wall Street Journal, Americans spend 18% of all food stamps at Wal-mart, which is approximately $14 billion. The new Farm Bill, approved by the Senate on Feb. 5, cut another $8.6 billion out of the budget, so this issue may become a trend. We'll have to wait until Feb. 20 to really know what impact cuts had on fourth quarter earnings, but I suspect EPS will be much lower than guidance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.