Underlying Vs. Reported EPS -- Did Wal-Mart Miss Or Beat Consensus?

Feb.23.14 | About: Wal-Mart Stores, (WMT)

Investors look at many numbers, but EPS is arguably the most important. EPS gets the most media attention, and stock analysts issue estimates that are compiled into a consensus. These estimates provide investors with an expectation of future performance. If the stock beats the consensus, it's called a surprise, and the price moves higher. If it's below, the price moves lower.

Wal-mart (WMT) announced Q4 earnings on Feb. 20. According to the 4th quarter conference call:

On a consolidated basis, Wal-Mart's underlying EPS rose 2.0% for the full year to $5.11, including the fourth quarter's EPS of $1.60. On a reported basis, EPS for fiscal 2014 decreased 3.2% to $4.85, including $1.34 in the fourth quarter.

It's hard to know if Wal-Mart beat or missed with this language:

"The numbers were in line with estimates", said Brian Yarbrough, a consumer research analyst at Edward Jones, "so Q4 was fine,".

But is Yarbrough referring to the numbers being "in line" with consensus estimates or company guidance? And are those estimates based on underlying or reported EPS? The former leaves Wal-Mart ahead of consensus, the latter far behind. Furthermore, one is right and the other is wrong.

Did Wal-Mart miss or beat estimates?
If the market is to judge, Wal-Mart missed estimates. The stock dropped $0.48 per share (0.64%) in pre-market trading on the news, and closed the day down $1.33 to $73.52.

Other interpretations of company results appear mixed. One report says:

Shares of the blue-chip company dropped 2% on sluggish results and below-consensus outlook.

However, Morningstar data shows Wal-Mart beating consensus estimates by $.01 for the quarter, and another story had the following lede: Wal-Mart Stores reported Q4 EPS of $1.60, $0.01 better than the analyst estimate of $1.59.

Other headlines include:

Wal-Mart Stores, Inc. Beats EPS Estimates; Guides Below Views; Raises Dividend

Wal-Mart earnings badly miss expectations

So who's correct? Technically they all are, but the truth depends on the definition of earnings. Wal-Mart provides the following explanation about the difference between "underlying" and "reported" EPS:

The underlying diluted earnings per share from continuing operations attributable to Wal-Mart ("Underlying EPS") for the three months and the fiscal year ended Jan. 31, 2014 is considered a non-GAAP financial measure under the SEC's rules because the Underlying EPS for each such period includes certain amounts not included in the diluted earnings per share from continuing operations attributable to Wal-Mart calculated in accordance with GAAP ("EPS") for the three months and the fiscal year ended Jan. 31, 2014.

Clearly, diluted or reported earnings per share is not the same as underlying EPS. Underlying is based on an adjustment, whereas diluted earnings are reported to the SEC. Analysts should be using diluted or reported EPS to build consensus estimates if only to maintain a clear basis for comparison against prior years.

Reported earnings
Let's see how Wal-Mart reported earnings on the Q4 call last year. Carol Schumacher, Vice President of Investor Relations for Wal-Mart Stores, Inc. had this to say:

In all references to earnings per share or EPS conversationally, we mean diluted earnings per share from continuing operations.

The following chart was taken directly from this year's Q4 earnings press release and it shows diluted net income per common share -- the GAAP measure that Wal-Mart reported last year -- compared to this year.

Click to enlarge

These are the reported earnings that analysts have estimated historically. The consensus estimate for the fourth quarter was $1.59, the actual reported EPS was $1.34.

Underlying earnings
This quarter Schumacher updated the language to include "underlying" earnings per share.

In this quarter we have significant discussion about underlying performance. Underlying EPS - by Wal-Mart standards - is calculated to adjust for the impact on the company's reported EPS for the fourth quarter and the full fiscal year of certain discrete items that totaled $0.26 per share and that occurred in the fourth quarter.

Discrete items are considered infrequent or unusual in nature -- the determination of which is left to the company. Wal-Mart lists their discrete items for the year below. The total impact to EPS was $.26 per share:

Brazil non-income tax contingencies $ 0.06
Brazil employment claim contingencies $ 0.05
Brazil and China store closures $ 0.06
China store lease expense charges $ 0.03
India transaction $ 0.05
Sam's Club U.S. staff restructuring and club closure $ 0.01
Click to enlarge

In other words, without these one-time expenses Wal-Mart's diluted earnings per share would be $1.60 EPS. This is what is referred to as the underlying EPS; it is a conditional measure of performance.

Wal-Mart also published the following chart as a reconciliation between underlying and reported EPS:

Underlying EPS

Three Months Ended

January 31, 2014

Fiscal Year Ended

January 31, 2014

Diluted net income per common share:
Underlying EPS $1.60 $5.11
Adjustments to Underlying EPS
Brazil Taxes (0.06) (0.06)
Brazil Employment Matters (0.05) (0.05)
Store Closures (0.06) (0.06)
Lease Matters (0.03) (0.03)
India Transaction (0.05) (0.05)
Sam's Restructuring (0.01) (0.01)
EPS $1.34 $4.85
Click to enlarge

Bottom-line -- The consensus estimate for the fourth quarter was $1.59, the actual reported (diluted) EPS was $1.34, however, underlying EPS was $1.60. If the consensus is based on underlying EPS, Wal-Mart beat estimates by $.01, but if the consensus is based on reported (diluted) EPS, Wal-mart missed consensus by $.25.

So What
Wal-Mart provides two reasons for the dual EPS reporting system this year. The first reason is that underlying EPS provides a better comparison to diluted EPS from continuing operations for the previous year. The second reason is that it affords investors the ability to make a more informed assessment of core earnings. Both are true, but special care should be taken to make sure the terms remain clearly defined.

I don't believe Wal-Mart's intentions were to mislead, but somewhere along the line "underlying" became synonymous with "reported" and now the confusion is setting in. It's hard to know what effect, if any, that confusion will have on stock price.

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.