Operating Efficiencies Should Support Wal-Mart’s Stock

-9.95%
Downside
60.17
Market
54.18
Trefis
WMT: Walmart logo
WMT
Walmart

Wal-Mart (NYSE:WMT) recently announced that its overall profit margins had declined in the second quarter of 2010. However, the retail giant was able to offset shrinking margins with successful cost-cutting efforts. Given the slow pace of economic recovery, management emphasized that Wal-Mart remains committed to cutting costs going forward.

Wal-Mart is the world’s largest retailer, competing with the likes of Target (NYSE:TGT), Costco (NASDAQ:COST) and Best Buy (NYSE:BBY). Based on the company’s second-quarter earnings report, we have modestly increased the Trefis price estimate for Wal-Mart’s stock, from $65 to $65.42. Our analysis follows below.

Margin squeeze

Relevant Articles
  1. Where Is Walmart Stock Headed Post Stock Split?
  2. Up 7% Already This Year , Where Is Walmart Stock Headed Post Q4 Results?
  3. Up 18% This Year, Will Walmart Stock Continue To Grow Past Q3?
  4. Can Walmart’s Stock Trade Lower Post Q2?
  5. Walmart Stock Likely To See Little Movement Post Q1
  6. Walmart Stock To Trade Lower Post Q3 Results?

Wal-Mart’s overall profit margins fell in the second quarter, driven by reduced margins at the company’s U.S. stores. Wal-Mart’s U.S. stores division constitutes roughly 62% of the stock’s value according to our estimate.

We expect the U.S. stores division to maintain gross margins of about 27% during the Trefis forecast period. You can drag the trend-line in the chart below to create your own margin forecast for Wal-Mart’s U.S. stores and see how it impacts the company’s stock price.

Despite lower profit margins, Wal-Mart U.S. reported roughly flat growth in both revenues and operating income. This shows that the retail giant has managed to offset declining margins by reducing its operating costs.

The next interactive chart shows our forecast for Wal-Mart’s sales, general and administrative expenses (SG&A) as a percentage of gross profits. You can drag the trend-line to create your own SG&A forecast and see how it impacts Wal-Mart’s stock price.

Cost-cutting efforts bear fruit

Labor productivity: Wal-Mart’s store managers delivered a 2.8% increase in labor productivity during the second quarter. As in past quarters, labor productivity benefited from scheduling systems that match associate hours with customer traffic.

Advertising strategy: Wal-Mart also changed its advertising strategy. As a result, media expenditures dropped in the second quarter to match historical trends. This decline followed a significant increase in ad spending during the first quarter of 2010.

Management incentives: Wal-Mart’s management incentive plan is tied to sales and other performance metrics. U.S. sales fell short of Wal-Mart’s expectations during the first half of 2010, resulting in reduced accruals to the incentive plan.

We also note that Wal-Mart is expanding the use cost-effective fuel cell technology to power its stores. Currently, each fuel cell can generate up to 60% of power needs at Wal-Mart’s larger stores.

As discussed, we expect Wal-Mart’s SG&A cost curve to remain flat during the Trefis forecast period. However, there could be a 6% downside to our stock price estimate if SG&A costs were to increase in future, matching historical levels.

You can see the complete $65.42 Trefis price estimate for Wal-Mart’s stock here.