Wal-Mart’s Results Will Be Weighed Down By Weak Economy And Inventory Pile Up

November 11th, 2013 by Trefis Team
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Retail giant Wal-Mart (NYSE:WMT) will come out with its fiscal third-quarter earnings on November 14, and we expect its results to once again be weak due to the sluggish economic environment in the U.S.  The retailer’s comparable store sales have declined in each of the last two quarters due to cautious consumer spending.  We do not expect the scenario to be any different this quarter. Much of the U.S. retail industry is going through a slump as consumers are spending more on long-lasting products such as automobiles and furniture while holding back on other categories such as apparel and general merchandise. Weakness in the retail market is evident from the fact that Wal-Mart has already reduced orders with its vendors due both to low demand and growing inventory.  This excess inventory could prompt stronger  promotional activity, which would weigh on the company’s comparable stores sales and gross margin.
Our price estimate for Wal-Mart stands at $81, implying a premium of 5% to the market price.

See our complete analysis for Wal-Mart

U.S. Retail Market Is Going Through A Rough Phase

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This year, growth in the U.S. retail industry has been particularly weak due to a number of factors that have impacted consumer spending. This weakness has been reflected in Wal-Mart’s results.  The company accounts for about 10% of n0n-automotive consumer spending in the U.S. and caters to more than 100 million customers every week. Due to the impact of 2% payroll tax increase at the beginning of the year, higher health care costs, and increased gasoline prices, U.S. buyers have been spending more cautiously. Even essential items such as groceries have been hit.   Wal-Mart reported negative comparable store sales growth for this category during the first quarter, though there may be competitive issues at play as well. Since the economic scenario has not changed much, we expect this trend to continue to impair Wal-Mart’s sales growth in the third quarter.

Moreover, there has been a noticeable change in consumer spending patterns as U.S. shoppers have diverted some of their spending to cars and houses to take advantage of low interest rates. Consequently, they are spending less on other products. As a result, U.S. retail sales, excluding the automotive sector, increased by just 0.1% in August, which was significantly lower than the expected 0.4% growth. [1] [2] Moreover, the retail market growth remained modest in September on account of low consumer confidence arising from slow job growth and the budget fight in Washington.

Inventory Pile Up Will Impact Sales & Margins

Last month, Wal-Mart’s purchasing managers sent several “pull-back” emails to its vendors to cut supply orders for the third and fourth quarter. [3] It appears that the retailer took this decision to address inventory accretion caused by weak sales growth. Wal-Mart plans to keep its inventory growth rate slower than the sales growth rate to manage its inventory more effectively. However, in the first quarter of fiscal 2014, Wal-Mart’s sales increased by just 1% and its inventory levels grew by 4.5%. This trend continued in the second quarter as the retailer’s inventories increased by 5.5% while revenue growth stayed at 2.3%. As a result of this weaker-than-expected sales growth, Wal-Mart ended  the first half of fiscal 2014 with surplus inventory.

Being the pioneer of modern supply chain management, Walmart is unaccustomed to this sort of  inventory hangover.  Holiday demand is thus key to fiscal fourth-quarter performance.  We believe that the company can clear the excess inventory by offering promotional discounts on its products. However, this will weigh on the company’s comparable store sales growth as well as its margins. Nevertheless, since the company had already pulled back several supply orders, the negative impact on its margins may be less profound.

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Notes:
  1. Forecast Envisions A Weak Holiday Season, The Wall Street Journal, Sept 17 2013 [↩]
  2. Retail sales fall short in August, temper fed speculation, CNBC, Sept 13 2013 [↩]
  3. Wal-Mart Cutting Orders as Unsold Merchandise Piles Up, Bloomberg, Sept 26 2013 [↩]