Can Walmart Turn Things Around?

Uncle Sam’s retail brainchild, Walmart (NYSE:WMT), enjoyed dominance in the industry for over decades. While the company still holds numerous laurels and achievements to its credit, the shift in competitive landscape is one that Walmart was slow to realize, or probably considered trivial. E-commerce is instrumental to gaining market-share as shoppers increasingly prefer online shopping. Wal-Mart has expanded online grocery pickup to more than 60 markets and is testing unconventional methods like leveraging on Uber, Lyft and Deliv for grocery delivery and smaller-format Neighborhood Markets.

While Walmart is exploring additional growth options like investments in associates, decision needs to be weighed against near-term profitability as food deflation and dollar strength is expected to add pressure.

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Digital, Price Promotion and Traffic to Boost Sales

Walmart’s promotion of low-prices, digital adoption with marketplace stock keeping unit (SKU) expansion, acquisition of Jet.com and growth in online grocery pickup are evidence that it’s taking steps to fight its biggest rival, Amazon. Comparable sales will rise as long as fuel prices stay accommodative and help drive trips to stores. Also, double-digit online sales gains and strength in grocery, should help boost revenue. Traffic may be the largest driver for Walmart’s U.S. store sales, given food exposure, which is a contrast to some of Walmart’s competitors.

Walmart’s business in U.S. which contributes 62% of total revenue, delivers consistent same-store sales gains, led by rising traffic and digital. Sam’s Club, 12% of sales, is also improving. International sales (26%) remain strong with the exception of the U.K. and China.

In Favor of Walmart

Walmart enjoys several scale economies. In particular, it gives the retailer better power to negotiate lower prices from vendors, helping it remain competitively priced vs. rivals. Wal-Mart accounts for 14% of Procter & Gamble sales, 26% of Kraft’s and 21% of General Mills’ – the largest end retailer for all the three. The chain is also an important customer for other multinational companies and can leverage its buying power to offset increased costs in other areas, such as wages, transportation and supply chains.

Walmart is also expanding its smaller-store format and the good news is that it works. Walmart is using Neighborhood Market (NM) stores as the primary vehicle, after closing all 102 Express stores. NM stores average about 40,000 sq. ft., less than a fourth of the 175,000-sq. ft. super-centers. Their comparable sales have outpaced the chain-wide average. Walmart plans to add 85-95 NM stores in 2016 to take market share from local grocers, dollar and convenience stores.

Second Quarter Earnings

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The International segment posted another quarter of healthy overall sales trends, with six markets’ SSS coming in over 4%. International segment sales fell -6.6% YoY dragged down by a $2.7B currency headwind. Sales in constant currency rose 2.2% YoY to $31.3B in 2Q, reflecting SSS growth of ~0.5%. During the quarter, Grocery sales at Walmart registered strong traffic in food and consumables. Food deflation of -1% YoY partially offset the benefit from increased traffic. Sales of health and wellness products aided a strong support (segment sales up mid single digits YoY) as branded drug inflation and growth in pharmaceutical scripts, including OTC, boosted merchandise performance.

Walmart’s Mexican chain, Walmex (SSS up 7.3%) delivered best revenue growth while Brazilian stores performed well to help drive comp growth, despite challenging economic conditions. Extensive promotions by online competitors and bad weather caused degrowth in same store sales. However Walmart posted continued market share gains in the Chinese hypermarket channel.

Summary

Walmart’s aim to boost its digital business, along with a focus on grocery delivery in the U.S. should help it better compete with Amazon and prevent market-share loss. Sales strength in the U.S. and abroad, with the exception of U.K. and China, show its focus on value is resonating with shoppers and spurring trips to stores. Strategy to improve margins is a bit trickier and the safest path is lower product costs, leaner inventory and optimal stock build up. Walmart’s operating margins face challenges from stronger U.S. dollar and increase in wage, digital investments, and higher shipping costs. Such factors may test Walmart’s near term performance as it cycles past the first phase of pay increases from April 2015. Gross margin is expected to expand from reduced transportation costs and improved margin rates in grocery, and health and wellness, partially offset by food deflation. Optimal and lean inventory practices could continue to offset some or all expense pressure. Walmart’s current operating margin lags that of Target’s. However, both fare better than Kmart which is incurring operating loss.

Also, Walmart’s recent traffic and ticket trends fare better when compared to the general softness in the industry. A possible reason could be that Walmart’s greater exposure to food / commodities, even with deflation. The neighborhood market strategy, which is delivering same-store sales growth above the U.S. segment, should aid in sales gains as these stores may also be used to fulfill online orders.

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