Earnings Preview: Longer Term, Wal-Mart Needs To Be More Productive

| About: Wal-Mart Stores, (WMT)

Summary

Home Depot's model since 2011 is the likely answer for retail, particularly for Wal-Mart.

There have been some areas of improvement for Wal-Mart since the traffic pressure started in early '15.

Still, longer-term pressure from Amazon is death by water torture for the retail giant.

Wal-Mart (NYSE:WMT), the enormous retailer that is in the midst of watching its formidable "EDLP" (everyday low price) business model be disintermediated or eroded by Amazon (NASDAQ:AMZN) almost on a daily basis now, reports its fiscal Q1 '17 financial results after the bell on Thursday, May 19, 2016.

Street consensus is looking for $0.88 in earnings per share on $113.2 billion in revenue for expected year-over-year declines of -14.5% for earnings and -1.4% for revenue.

This is the 4th of the last 5 quarters of negative y/y revenue growth and the 9th of the last 10 quarters of negative y/y earnings per share growth.

A pretty unprecedented period of no growth for Wal-Mart.

Now, here has what has gone right recently:

1.) Comp attribution - traffic positive once again

WMT

comp

Avg.

ticket

Traffic

1/16 q4 +0.4% +0.7% +1.4%
10/15 q3 +1.5% -0.2% +1.7%
7/15 q2 +1.3% +0.5% +0.80%
4/15 q1 +1.0% +1.0% +0.1%
1/15 q4 +1.5% +0.1% +1.4%
10/14 q3 +0.5% +1.2% -0.7%
7/14 q2 0% +1.1% -1.1%
4/14 q1 -0.2% +1.3% -1.4%
1/14 q4 -0.4% +1.3% -1.7%
Click to enlarge

Source: Earnings reports, Street research

Traffic is the key to Wal-Mart's business. Without traffic, the company struggles, and if it relies on "average ticket" to generate positive comps in effect, it is thwarting the design of the EDLP model.

As of the January '16 quarter, the traffic comp had improved for 5 straight quarters.

The Wal-Mart model is based on "high-turnover, low margin" when thinking of the DuPont Roe model (i.e., asset turnover). Traffic is king for the retail giant.

2.) Gross margin has improved 5 straight quarters, although the wage hike offset that gain as SG&A increased and cut into the operating margin. Still, Wal-Mart is using gross margin to offset some of the wage-hike pressure.

3.) The dollar is starting to weaken. The year ended January '16 saw what was the equivalent of a $17 billion hit to revenue from forex. It was the worst year ever in terms of negative revenue growth for Wal-Mart, with most of that due to currency.

4.) Food deflation has been a killer for the retail giant, and that may not abate anytime soon if Amazon has its way in grocery, as I wrote about last week here. The deflationary impact of Amazon on Wal-Mart's business has been legendary, but recent inflation data, mostly wage data (a lot of that could be a function of Wal-Mart's wage hike to the rank and file) and the ending of the 5-year bear market in commodities might actually be a positive for the company in the long run.

5.) Only 1 quarter of the last 15 has seen sales growth exceed inventory growth for the retail giant, and that was July '15, where inventories fell 1% yoy, while revenue was flat. This is another metric where traffic through the turnstiles "engages" the model. This isn't a positive, but calendar 2015 inventory-to-sales growth was looking better. The January '16 quarter wasn't so great, though.

6.) The curbside pickup for grocery shoppers seems to be well received given the headlines, but there are no metrics on it that I've heard of. What percentage of Wal-Mart grocery shoppers pick up curbside, rather than enter the store? What analysts haven't said yet is fewer people in the store for grocery shopping could mean fewer purchases of convenience items that might have been bought with grocery. Does curbside traffic count as "traffic" for comp calculation?

The endgame for Wal-Mart - fewer but more productive stores, which is the Home Depot (NYSE:HD) model.

This may have been the best article I've ever written for Seeking Alpha, where I examined Home Depot's model and the increase in the stock price from the low $30s to the $100 level and what drives its tremendous and remarkable shareholder value.

Home Depot reported earnings this morning, and the company opened one new store over the last year.

What HD did (starting in 2010, 2011) was become remarkably more productive at the store level, increasing operating margin - actually doubling it over a 3-4 year time period - increasing sales per square foot, average ticket and such, all without new stores.

The one advantage Home Depot has is that the "do-it-yourself" (DIY) home improvement model is one of the few areas of retail somewhat insulated from Amazon's encroachment.

The endgame for Home Depot was an incredible increase in its free cash flow, which, along with debt issuance, resulted in substantial share buybacks for the DIY giant, driving substantial returns and shareholder value since mid-2011.

Unfortunately, most of Wal-Mart's merchandise is ripe to be picked off by the Amazon model.

Can Wal-Mart replicate HD, and more importantly, would it want to? Do the Walton family and Doug McMillon have the chops to really adjust the Wal-Mart model and think that new stores aren't the answer?

Corporate cultures can take generations to change, and very often, it is why second-generation leaders often fail as corporate leaders.

Amazon is the death star today, and Wal-Mart is firmly in its gun sight.

Conclusion

Personally, I was long a champion of Wal-Mart, Sam Walton and the family and the retailer in general, despite the negative, often union-generated articles trashing the company. Wal-Mart was, or is, America's single largest private employer, but I do believe the threat of Amazon is too great to continue to think that like the Saturday Night Live skit with Christopher Walken calling for "more cowbell", the answer for Wal-Mart is more stores.

Amazon is, without a doubt, the stiffest and most formidable competitive threat Wal-Mart has faced as a public or private company, and it isn't going away.

I was puzzled by Mr. Trump's comments about Amazon being subject to antitrust issues, if only because Wal-Mart's expected revenue in fiscal '17 (ends January '17) is still 3(x) the amount of Amazon's annual revenue.

Wal-Mart is still the king, and every day millions of Americans cruise through those doors looking for everyday general merchandise. Its expected "average" EPS and revenue growth over the next 3 years is 0% and +3% given current consensus.

America's retail brick-and-mortar giant has to figure out how to grow again, and the sooner the better.

Disclosure: I am/we are long AMZN, WMT, HD.

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.