Source: The New York Times
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Wal-Mart (WMT) reported quarterly revenue of $123.4 billion and earnings per share of $1.08. The company beat on revenue by over $500 million, but earnings guidance was disappointing. The stock fell 2% on the news. I had the following takeaways on the quarter.

E-commerce Growth Was Strong Again

Wal-Mart generated low single-digit growth Y/Y within Wal-Mart U.S. and Sam’s Club. It was offset by -1% growth in Wal-Mart International, while total revenue was up 2%. The devil is in the details however, as investors tend to focus on the quality of Wal-Mart’s revenue growth.

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The 2% growth was stronger than the 1% increase reported last period mainly because Wal-Mart International’s decline was not as pronounced; last quarter its revenue fell 4% Y/Y. The company’s U.S. comp sales increased 1.8%, in line with expectations. The metric investors waited with bated breath for was online sales, and Wal-Mart delivered in spades. E-commerce sales grew by 67%, broadly in line with the 69% growth achieved last quarter.

While last quarter was a very pleasant surprise, this quarter’s results solidified Wal-Mart’s success in transitioning into an online operator. The company took a major hit a year ago when online sales growth was in the single digits. It acquired Jet.com in Q4 2016 for $3 billion to help beat back the Amazon (AMZN) threat, and also added MooseJaw, Shoebuy, etc., to its online offerings. According to management, the lion’s share of the growth was organic through Walmart.com as the company offered customers a wider array of assortments; SKUs through Walmart.com now exceed 67 million.

Operating Margins Suffered

The fall out from online growth is that it usually comes at lower margins vis-a-vis bricks and mortar stores. That could be due to shoppers exploiting different price points online versus in-store, or the increased technology costs needed to provide a best-in-class online experience. Wal-Mart’s gross margin declined to 25.8% versus 26.0% in the year earlier period; operating and SG&A expenses were 21.0% (versus 20.9% last year) and operating income margin was 4.8% versus 5.0% in the year earlier period. Given sales of over $123 billion these small percentage changes can have a meaningful impact on the bottom line.

In my opinion, Wal-Mart will likely continue to experience higher SG&A expenses. Rising SG&A and technology costs are a way of life of online retailers. They have to continue to spend to attract customers and remain competitive with Amazon. Last quarter the company offered free 2-day shipping on certain items with a basket size of $35 or more; it also launched Pickup Discount which allowed customers who order non-store products online to pay a discount for picking the items up in nearby stores. The discounts allow Wal-Mart to forgo the costs of shipping items to a customer’s home.

According to management, the offers were met with success by customers this quarter:

Walmart U.S. e-commerce again performed very well on the top-line as GMV grew 67% and sales increased 60%, including acquisitions. The majority of this growth was organic through walmart.com, including Online Grocery, which is growing quickly. We are delivering growth through an improved customer value proposition that includes free two-day shipping on millions of items.

While such value propositions likely aided Wal-Mart in its robust online sales, they also likely contributed to the tick down in margins. While the company is delivering sales through additional distribution channels, it has to spend more and work harder to achieve those sales.

Weak Guidance

Wal-Mart delivered a solid quarter, yet management gave weak guidance. The company guided that Q3 eps would be around $0.90 to $0.98, below a previous estimate of $0.99. The company expects full-year eps from $4.30 to $4.40; the mid-point of the full-year eps of $4.35 is slightly higher than the previous mid-point of $4.30. WMT sold off immediately on the disappointing guidance and finished down 2% post-earnings.

As Wal-Mart becomes more of a hybrid retailer – a cross between online and brick-and-mortar – it might be able to sustain its revenue base, but its margins and earnings could erode from here. WMT bulls should look on the bright side though. It’s better to cannibalize your own sales than have Amazon do it.

Takeaway

Wal-Mart’s earnings growth does not justify its 18x p/e multiple. Avoid the stock until the slide in its operating income margins bottom. That could be a while.

On Shock Exchange

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