story by Kim Souza
ksouza@thecitywire.com
Wal-Mart Stores posted second quarter net income of $3.475 billion, 15% below the same period in 2014 and well below the consensus of analyst estimates. Lower margins on U.S. sales and ongoing investments in wages and e-commerce not only hit the bottom line, but caused execs with the retailer to lower earnings guidance for the rest of the year.
The per share earnings of $1.08 missed the consensus estimate of $1.12. However, the company said in its Tuesday morning (Aug. 18) quarterly earnings report that currency exchange issues resulted in a loss of 4 cents from per share earnings.
On the upside, the company reported a 1.5% increase in comp sales and healthy 7.3% comp sale increase in its Neighborhood Market stores. Global ecommerce sales rose 16%.
Wal-Mart Stores CEO Doug McMillon noted the pressure on near-term financial performance because of the investments in raising wages, employing more people and adoption of new technologies.
“We're pleased that the investments we've made are helping to improve our business. Even if it's not as fast as we would like, the fundamentals of serving our customers are consistently improving, and it's reflected in our comps and revenue growth,” McMillon said in the report. “In this case, our desired changes require investments, which are pressuring earnings this year. We're confident that our strategic plan will create robust sustainable growth for shareholder returns over time.”
Total quarterly revenue was $120.229 billion, just ahead of the $120.125 billion during the same quarter of 2014.
LOWER GUIDANCE
The company also lowered its full-year earnings guidance from a range of $4.70 to $5.05 per share to $4.40-$4.70 per share. The cost of higher wages, training and more store workers will pull 24 cents from per share earnings for the year, with 8 cents of that coming in the third quarter. Investments in e-commerce is estimated to lower full year earnings per share by between 6 cents and 9 cents.
Chief Financial Officer Charles Holley said full year profits would also be down an estimated 11 cents from ongoing shrink in U.S. stores and lower pharmacy margins. Also expected to hit the bottom line is a projected 15-cent charge related to currency fluctuations against a strong U.S. dollar.
Holley said the shrink issue is broad-based and includes theft, but also includes timely mark downs and fresh food rotation which he said is being addressed by better training and adding more labor back to the stores with the return of department managers and greeters.
“We continue to invest in our business to enhance the customer experience. Operating profit will be pressured for the remainder of the year, due to continued investments in store associate wages and additional hours, as well as headwinds from pharmacy reimbursements and ongoing shrink, primarily in Walmart U.S.,” Holley said.
For the first half of Wal-Mart’s fiscal year, revenue totaled $235.055 billion, just under the $235.085 billion in the same period of 2014. Net income for the first half of the fiscal year was $6.816 billion, below the $7.686 billion in the same period of 2014.
Although total revenue was up during the quarter, operating income fell in the retailer’s three primary divisions. Operating income during the quarter at Walmart U.S. was $4.819 billion, down 8.2%. Operating income at Walmart International was $1.277 billion, down 14.2%, and operating income at Sam’s Club was $428 million, down 13.4%.
SLOWER GROWTH
Brian Yarbrough, analyst with Edward D. Jones, told The City Wire he expected Wal-Mart to lower earnings guidance for the balance of the year because spending is up and growth has slowed with the retailer not opening nearly as many stores as it has in past years.
He said in Wal-Mart’s big growth period it was opening 500 to 600 supercenters a year. Wal-Mart said it still plans to open between 60 and 70 supercenters this year. While the focus has turned to smaller grocery formats like Neighborhood Market, Yarbrough said the grocery stores can’t do the volume of a supercenter.
Holley said Wal-Mart has opened 350 Neighborhood Market stores in the past two years, and they are performing well. That said, Wal-Mart has opted to slow the growth of this format in certain areas going forward. He said Wal-Mart is now focused on quality of stores, not just quantity.
Yarbrough also agreed that the proliferation of Neighborhood Markets in close proximity to supercenters is having a cannibalization impact on Walmart U.S. stores. For example in Bentonville, the retailer built three new Neighborhood Markets within less than 3 miles of the city’s lone supercenter. Two of those opened this year and a fourth one will open before the year ends.
Yarbrough said the International segment, largely viewed as Wal-Mart’s growth engine in the past, has become a liability to earnings given the negative currency fluctuations and ongoing challenges presented in the foreign markets. International CEO David Cheesewright said in the earnings call that economic challenges in the U.K., Brazil and China are expected to endure for the rest of this year while Mexico and Canada should continue to perform well.
E-COMMERCE SPENDING
Holley said in the media call that Wal-Mart spent $760 million in the quarter to acquire the remaining 49% of Yihaodian, the online retail site in China which now has 100 million registered users. Neil Ashe, CEO Of Wal-Mart Global e-Commerce, said the company plans to situate Yihaodian for long-term growth.
“Our primary goal is to continue to accelerate Yihaodian’s core e-commerce business and maintain strong local Chinese expertise. Now that we are the sole owners, we will be expanding our leadership team from within the Yihaodian business, from within Walmart and from the e-commerce industry in China. We will also leverage Walmart’s global reach and scale to better benefit Yihaodian, including global sourcing ... China is an exciting, dynamic, large and competitive market. We are excited about our long-term opportunity in China,” Ashe said.
The retailer also plans to open two online fulfillment centers in the back half of this year so that Walmart.com is within two days delivery of roughly 98% of the U.S. population.
While the e-commerce spending is deemed vital to the future retail experience, it is a drag on the retailer’s profits which still are largely centered around a U.S. grocery business that returned flat margins in the recent quarter.
Yarbrough said for much of the last three decades, Wal-Mart was the disrupter that turned the traditional grocery on its head. Now it seems Amazon is doing the same thing with e-commerce. Yarbrough and other analysts like Ben Bienvenu at Stephens Inc. support the investments in e-commerce for the company’s long-term viability, but also note there is short-term trade-off in bottom line profits.
FCPA COSTS
Another drag on earnings and a possible reason why stock buybacks have been drastically reduced in recent years is the ongoing Foreign Corrupt Practice Act investigation, now three years in the books. Wal-Mart said in the release that it spent roughly $23 million in the recent quarter related to the investigation, and another $7 million was spent on its own global compliance program initiatives. The retailer said it spent $43 million in the year-ago period on these items. For the full year, Wal-Mart expects FCPA spending to range between $130 million and $150 million.
To date the retailer has spent more than $655 million in legal fees and compliance restructuring costs over the past three years.
In fiscal 2015 which ended Jan. 31, Wal-Mart said it spent $173 million on FCPA compliance-related costs. The majority of that — $121 million — was spent on legal costs associated with the investigation and additional inquiries. The remaining $52 million was spent on Wal-Mart’s internal compliance overhaul. In the prior two years, FCPA costs total $439 million for Wal-Mart, with $282 million in 2014 and $157 million in 2013.
At $173 million in fiscal 2015, the FCPA expenses equate to roughly the loss of a nickel per share in earnings last year. In the three years since Wal-Mart begin disclosing its FCPA-related expenses the impact to earnings is roughly 19 cents a share.
When the case is finally resolved, analysts expect the fines and total costs could reach up to 9% of the company’s total gross earnings, or approximately $7 billion.
STOCK PRESSURE
Wal-Mart shares (NYSE: WMT) opened lower on Tuesday (Aug. 18) with the lackluster news. Shares slid $2.07 to $69.84 in active trading during the morning session. Shares hit a new intraday 52-week low price of $69.55 dipping below the tested $70 range. During the past 52 weeks the share price has ranged from a $90.97 high to $69.55 low.
Yarbrough, ranks the stock a “hold” given the lack of growth he sees in the retailer’s core business. He does not own the stock and has forecast total sales will likely be down this year, compared to last.
He said the investors had been used to seeing around $6 billion annually in stock buybacks between 2010 and 2013, but that has been scaled back. In the recent quarter, Holley said the company repurchased approximately $1 billion in shares, the largest repurchase activity in the past four quarters.
“As always, we will remain opportunistic with share repurchase throughout the year. As of the end of the second quarter, we had approximately $9.0 billion remaining under our current $15 billion authorization,” which became effective June 7, 2013, Holley said.