Wal-Mart’s Q3 Results Disappoint But E-Commerce And Smaller Format Stores Provide Hope

by Trefis Team
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Retail giant Wal-Mart (NYSE:WMT) reported the third straight quarter of comparable store sales decline in the U.S. as its Q3 sales were weighed down by weak consumer spending and low store traffic. The company’s results are unlikely to get better in the fourth quarter as it expects the traffic decline to continue in the holiday season. However, despite the comparable store sales decline, Wal-Mart’s overall operating income increased by 3.6% driven by strong expense leverage. The retailer saw some positive signs for its business in the form of strong online growth and success of smaller format stores. Although these businesses are not big enough to have any material impact on Wal-Mart in the near future, they do hold good promise for the company’s long term growth.

Our price estimate for Wal-Mart stands at $81, which is just ahead of the market price. However, we are in the process of updating our price estimate in light of the recent earnings.

See our complete analysis for Wal-Mart

Q3 Recap And Q4 Outlook

Wal-Mart’s U.S. comparable store sales declined by 0.3% in Q3 fiscal 2014 driven by cautious consumer spending, 0.4% traffic decline, reduction in television prices and sluggish sales of toys and dry groceries. [1] [2] Wal-Mart mainly caters to low income customers who have been extremely reluctant in spending this year due to the payroll tax hike, higher healthcare costs and slow job growth. [1] Moreover, there has been a change in the consumer spending patterns where several buyers have diverted their spending to cars and houses to take advantage of low interest rates. Subsequently, they have prevented themselves from spending on general merchandise. In its international business, Wal-Mart’s comparable store sales declined by 2.8% in its biggest market Mexico owing to a 3.2% decrease in store traffic. The country’s recent economic slowdown appears to be the main reason for traffic decline. [2]

Wal-Mart’s sales are unlikely to get better in the fourth quarter as consumer spending and store traffic trends remain uncertain. Early forecasts for the holiday season suggest that this season’s store traffic will decline by almost 1.4%. [3] Moreover, the recent food stamp reductions will also hurt the retailer. Wal-Mart is one of the biggest beneficiaries of food stamps as buyers spend about 18% of all food stamp dollars at Wal-Mart. Congress slashed food stamp benefits last month, which will weigh on the company’s sales going forward. [4] Wal-Mart expects its sales to remain flat during the fourth quarter.

Expense Leverage Remains Strong

During the third quarter, Wal-Mart remained on track with its five year goal of reducing operating expenses as percentage of sales by 100 basis points. The retailer improved its expense leverage by 22 basis points by taking advantage of opportunities in areas such as technology, logistics, sourcing and workforce planning. Wal-Mart is increasing its store productivity by reducing the costs related to building, expanding and remodeling. During the past two years, the cost per square foot for new construction of both supercenters and small formats in the U.S. has come down by over 15%. As the retailer’s expense leverage remained strong throughout its businesses, its operating income grew across all its segments. [2] Going forward, we expect Wal-Mart to maintain its strength on this front.

Online Growth Emerged As A Positive Sign

Wal-Mart’s online sales increased by almost 40% during Q3 and it now expects its online revenues to cross $10 billion by the year end. About 20% of the rise in Wal-Mart’s online sales is attributable to last year’s acquisition of Yihaodian in China and remaining is attributable to organic growth. Although online sales currently account for just 2.1% of Wal-Mart’s revenues, they hold good promise for its long-term growth.

The company is looking to integrate its stores and e-commerce channel to provide a greater variety of products over the Internet. It plans to utilize its vast physical presence across the country as an e-commerce fulfillment network. Wal-Mart’s digital technology unit, @WalmartLabs, creates platforms and products around social and mobile commerce. During the quarter, @WalmartLabs team built a new sophisticated recommendation engine that was a huge improvement over its previous one. The retailer also accelerated the deployment of Pangea, its global technology platform running all its sites around the globe. This will allow Wal-Mart to constantly improve its front-end and back-end capabilities to enhance the website shopping experience. [2] The outlook for online retail growth in global markets is very optimistic and therefore, we believe that there is huge room for Wal-Mart’s online sales to grow.

Smaller Format Stores Continue To Perform Well

To continue expanding in the U.S. and fend off competition from local dollar stores, Wal-Mart has been aggressively expanding its smaller format stores, Neighborhood Markets and Wal-Mart Express, in densely populated urban areas. Since their launch, these stores have yielded good results for the company encouraging it to step up their expansion. Following healthy growth in the prior quarters, smaller format stores’ comparable store sales increased by 3.4% in the third quarter of fiscal 2014. Wal-Mart currently operates 300 such stores and plans to take this figure to 400 by the year end. [2] Moreover, for the first time Wal-Mart U.S. is planning to open more Express stores than its supercenters. Out of the 235-265 stores planned for fiscal 2015, 120-150 will be Express stores. Also, the retailer will start utilizing its large supercenters as ‘cross docks’ next year, to supply products to nearby smaller stores. [5] We believe that there is huge growth potential for such stores in the U.S. given that some dollar stores operate over 10,000 stores in the region.

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Notes:
  1. Wal-Mart’s U.S. sales miss mark as shoppers stay cautious, Reuters, Nov 14 2013 [] []
  2. Wal-Mart’s Q3 fiscal 2014 earnings transcript, Nov 14 2013 [] [] [] [] []
  3. ShopperTrak Expects Holiday Sales Will Increase in 2013, ShopperTrak, Sept 17 2013 []
  4. Walmart And Its Customers Pinched But Food Stamp Cuts, Huffington Post, Nov 14 2013 []
  5. Wal-Mart predicts sales will grow faster next year, Reuters, Oct 15 2013 []
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