Wal-Mart Earnings Preview: Low Expectations As Traffic Continues To Erode

About: Walmart Inc. (WMT)
by: Brian Gilmartin, CFA
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Forward EPS and revenue estimates have been negative.

It isn't the international segment but the US segment that is under pressure.

Stock pops when US comp's start to rise.

WMT "traffic" comps have declined for 6 straight quarters.

Wal-Mart (NYSE:WMT) the retail juggernaut reports their fiscal q2 '15 earnings results before the bell on Thursday morning, August 14th, with analyst consensus expecting $1.21 in earnings per share (NYSEARCA:EPS) on $119 billion in revenue for expected year-over-year decline in EPS of -2.5% on 2% revenue growth.

Both EPS and revenue consensus have come down since the May '14 earnings report. Consensus for the 2nd quarter after the May '14 report came in at $119.4 billion and $1.23 per share, so the pressure on WMT continues.

WMT started the year near $78 per share, so the stock is down around 5% year-to-date, not including the dividend.

Right around May, 2012, WMT started to run higher and took out the January, 2000 high of $70.25 in mid-2012 as US store comp's started to rise from 0% to 3%, but have since fallen back down to -0.1% to -0.4% in the last few quarters.

Another metric that has worried me about WMT which seems kind of obscure but will require some additional commentary is that WMT's "y/y sales vs inventory growth" has been below par for some time, and really WMT hasn't been able to grow revenues faster than inventories since pre-2009 or the Great Recession.

Yoy changes:       4/14 q 1/14 q4 10/13 q3 7/13 q2 4/13 q1 1/13 q4 10/12 q3
sales n/a n/a n/a 1% 1% 1% 2% 1% 4% 3%
inventories n/a n/a n/a 5% 2% 5% 6% 4% 8% 8%

* Source: internal spreadsheet

One of the first insightful and analytical articles I read on WMT was back in the mid 1990's by the Motley Food staff, where they described WMT as a "high volume, low turnover" business, which if you evaluate on the DuPont ROE model (standard CFA fare, for those committed and anti-social enough to sit through the exams) was a function of their asset turnover.

WMT lives and breathes by moving product through the stores and being a powerful merchandiser that can extract cost and cost concessions from their suppliers and in fact make their suppliers more efficient producers.

While asset turnover (which we track on our internal spreadsheet) has been stable between 2.25 and 2.50 the last 3 - 4 years, the fact is at times WMT has been able to generate "high 2's" for asset turnover, which greatly helps their margins.

Maybe it is Amazon, maybe it is the Dollar Store's and Dollar Tree's and the plethora of low-end competitors, maybe it is the lack of any appreciable price inflation, which would allow WMT to grow margin internally arbitraging their giant supplier base, vis-à-vis their store pricing, or it could be all of these things to some degree.

WMT US is still 60% of WMT revenues and 75% of WMT total operating income, so what happens in the US matters.

Here is another part of our spreadsheet that worries me:

n/a 1/15 q4 10/14 q3 7/14 q2 4/14 q1 1/14 q4 10/13 q3 7/13 q2 4/13 q1 1/13 q4 10/12 q3 7/12 q2 4/12 q1 1/12 q4      
Walmart US sales n/a n/a n/a $67,852 $76,433 $67,692 $68,728 $66,553 $74,665 $66,127 $67,357 $66,341 $72,789 $63,835 $64,893 $62,669
Walmart Us stores (Sam's) n/a n/a n/a 4,868 4,835 4,786 4,713 4,663 4,625 4,591 4,526 4,498 4,479 4,460 4,431 4,418
Avg rev's per store n/a n/a n/a $13.94 $15.81 $14.14 $14.58 $14.27 $16.14 $14.40 $14.88 $14.75 $16.25 $14.31 $14.65 $14.18
y/y growth n/a n/a n/a -2% -2% -2% -2% -3% -1% 1% 2% 4%        

* Source internal spreadsheet

Simply using US stores versus US revenues, the "average" revenue per store hit an air pocket beginning in mid-2012, and it may just be WMT's competitive response, to drive out the inefficient competitors, as it continues to deal with Amazon, which is not going to go away.

In the mid-1990's Joe Nocera, the famed New York Times business columnist who wrote a fabulous Saturday afternoon article, wrote a great article stating that it could be WMT that was the reason that we saw tremendous prosperity through the 1990's without any real CPI inflation.

When you now include Amazon into the mix, and bring us forward into 2014, think of what WMT and AMZN are doing to retail consumer prices, for the average American.

The question remains for me what restores WMT to what I think could be a high-single-digit and low-double-digit EPS grower, as the retail giant's revenues will likely be stuck in the mid-single digit range for the foreseeable future.

Valuation metrics:

With WMT trading at 15(x) expected 2015 EPS with 7% EPS growth expected over the next few years, with expected 4% revenue growth, the stock looks pretty fairly valued.

Using cash-flow metrics, with WMT trading at 11(x) cash-flow and 23(x) free-cash-flow (4-quarter trailing), there isn't much to like their either.

WMT is returning all of their free-cash to shareholders, about half of which is the dividend.

Ive often wonder on the eternal debate about whether "traffic or ticket (i.e. pricing power)" is more significant for retailers, and with WMT the problem with traffic seems obvious.

However sentiment is negative coming into this earnings report and I have always felt this is one of the strongest retail management teams in the world.

Could the $489 billion in expected fiscal '15 revenues mean WMT is subject to the law of large numbers ? Sure, but that has been the case for a while.

Technically, we would need to see WMT continue to trade above the $70.25 high tick from January of 2000, otherwise I would start to think the retailer is in a period of secular decline, and the pressure from Amazon is too great.

Fundamentally, what I will be looking for is:

a.) Better US store comp's and guidance;

b.) Faster inventory turnover;

c.) Better SG&A leverage (which is pretty good already);

Hopefully a little price inflation on the horizon.

Don't kid yourself: WMT is still one of the more formidable businesses and certainly retailers in the US today. I thought with better job growth, lower US jobless claims, and firmer US home prices, WMT would participate in the resurgence of the US economy.

I guess we'll see.

We are long about 2.2% - 2.5% long position within client accounts, and haven't changed it in some time.

The key technical ranges are $70.25 and the breakout in mid-212, and the all-time high from late, 2013 of $81.37.

As long as the stock is range-bound in the above boundaries, you can give it time.

Disclosure: The author is long WMT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.