Wal-Mart‘s (NYSE:WMT) shares increased by 5% after it reported strong results for its Q3 fiscal 2015. The retailer’s U.S. comparable sales increased for the first time in the last seven quarters and its EPS was able to beat street estimates. The retailer’s comparable sales in the U.S. increased by 0.5%, driven by an improvement in consumer confidence on account of the falling unemployment rate and lower gasoline prices. Fuel prices have reached their lowest levels in four years, and some buyers have diverted their gas savings to Wal-Mart stores.  However, despite the positive comparable sales growth, Wal-Mart’s overall revenues at $118 billion fell slightly short of Wall Street expectations of $118.3 billion. On the profit front, the company reported earnings per share of $1.15, which was three cents ahead of the consensus estimate. Wal-Mart paid a smaller amount in taxes during the third quarter, which positively impacted its profits. 
However, even with its improved performance in Q3, Wal-Mart’s full year EPS guidance remained muted. In fact, the new EPS outlook looks weaker than the company’s previous guidance. While the retail giant has raised the lower end of its guidance by two cents from $4.90 to $4.92, it has slashed the high end from $5.15 to $5.02, citing expenses related to store closures in Japan as one of the reasons.  On the top line growth front, Wal-Mart reiterated its guidance of a 2-3% increase in revenues, which was slashed from 5% last month. 
There were quite a few positives for the retailer in the quarter. The foot traffic decline at Wal-Mart was less severe compared to the industry-wide traffic decline. Comparable sales at small stores increased by a healthy 5.5% and online sales grew significantly during the quarter.  While both of these businesses are currently small, there exists an opportunity for the company to turn them into significant value contributors in the long run.
Our price estimate for Wal-Mart stands at $81, which is just below the current market price.
Traffic Decline Wasn’t Too Bad
While Q3 fiscal 2015 marked the second consecutive year of store traffic declines at Wal-Mart, the intensity of the decline was much weaker as compared to the entire U.S. retail industry. Foot traffic at Wal-Mart U.S. stores in the third quarter declined by just 0.7% from the year ago period.  In comparison, foot traffic across the retail market has declined by 5% sequentially in almost every month over the last few years.   In fact, traffic in September was 17% below what it was in the same month last year.  Interestingly, Wal-Mart’s store traffic in Q3 has actually improved from Q2 and Q1. It was 40 basis points ahead of its Q2 levels and 70 basis points more than what it was in Q1. Strong customer response during the back-to-school season and Halloween weekend helped the company reduce the intensity of its store traffic decline. Being the largest retailer in the country and accounting for almost 10% of non-automotive spending, Wal-Mart’s sales trends mostly coincide with that of the entire industry. However, significantly better traffic trends in Q3 suggest that the retailer is effectively leveraging its EDLP strategy to stay ahead of the industry in terms of traffic.
Small Stores Show Big Promise
Traditionally, Wal-Mart has been serving customers who make less frequent store trips, with its large stores located on the outskirts of a city. It hasn’t been as effective in catering to buyer needs for easy access, for which they usually go to a traditional convenience store. As a result, local convenience, dollar and grocery stores have been nibbling at Wal-Mart’s low-end customer base. Expanding its smaller format network provides Wal-Mart with a great opportunity to win back those customers, driving them from alternative stores to its Neighborhood markets.
While Wal-Mart’s Supercenters have been struggling with weak traffic for some time now, its small stores have performed much better. During the fourth quarter of fiscal 2014, comparable sales at small stores increased by about 5%. Interestingly, the figure has increased by a similar amount in all three quarters of fiscal 2015. In fact, the growth is accelerating. Comparable sales increased by 5% in the first quarter, 5.1% in the second and 5.5% in the third. However, since this format contributes just 10% of Wal-Mart’s net revenues, it hasn’t had a significant impact on its top line growth. Nevertheless, the U.S. market presents a huge opportunity for the retail giant to expand its small store network considerably. Although the company recently slowed the roll-out of its Neighborhood format, its plans still look aggressive compared to what its peers are doing.
Online Growth Continues; Business Need To Get Big
During the third quarter, Wal-Mart’s e-commerce sales continued their steady growth momentum. Global e-commerce sales increased by 21%, with sturdy performance in almost all markets. However, online sales contributed just 20 basis points to overall comparable sales and therefore did not have a notable impact on the company’s overall results. 
It is a well-known fact that e-commerce is the future of retailing in the U.S. With growing Internet penetration, proliferation of smartphones and tablets, the convenience of online shopping and appealing discounts and incentives, the e-commerce industry has grown at a robust pace over the past five or six years, which is likely to continue in the future. Buyers are gradually shifting from store shopping to online shopping, which is evident from the industry-wide decline in foot traffic and continual growth in e-commerce sales. While almost all retailers have acknowledged the ongoing shift towards e-commerce, several big names have been unable to translate their respective web channels to formidable businesses.
For Wal-Mart, e-commerce accounts for just 2% of its overall revenues and the figure has increased by only about 50 basis points over the last year and a half despite the retailer’s aggressive efforts.  As a result, rather than growing e-commerce as a separate channel, Wal-Mart is looking to integrate its physical and digital channels. Known as omni-channel retailing, this has become a prevalent trend in the industry. While the retail giant has deployed several initiatives – such as “buy online and pick up in store” and layaway – to bolster its omni-channel platform, it still remains far from its goal. Nevertheless, it is a start and Wal-Mart must take giant strides from here on to expand its online business. In a recent update, the company stated that it is planning to increase investments in e-commerce by close to 50% next year.  It is a sign that the company has come to terms with the fact that without aggressive investments, the channel’s contribution will remain insignificant.Notes:
- Gasoline Savings Flow To Wal-Mart’s Carts, The Wall Street Journal, Nov 13 2014 [↩] [↩]
- Wal-Mart Posts Earnings That Top Estimates After Sales Rise, Bloomberg, Nov 14 2014 [↩]
- Walmart Reports FY15 Q3 EPS of $1.15, Walmart, Nov 13 2014 [↩]
- Walmart will accelerate investments in e-commerce and moderate global square footage growth, Walmart, Oct 15 2014 [↩] [↩]
- Wal-Mart’s Q3 fiscal 2015 earnings transcript, Nov 13 2014 [↩] [↩] [↩]
- Shoppers Are Fleeing Physical Stores, The Wall Street Journal, Aug 5 2014 [↩]
- Back-To-School Slump Raises Concerns About Holiday Season, Bloomberg, Sept 23 2014 [↩]
- Brick-and-Mortar traffic falls 17% in September, Retail Dive, Oct 10 2014 [↩]