Trouble Ahead for Wal-Mart

The discount giant trims third-quarter guidance.
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Updated from 7:39 a.m. EDT

A strong July salvaged

Wal-Mart's

(WMT) - Get Report

second quarter, but the retail titan warned Tuesday that high gasoline prices could squeeze the rest of the year.

Wal-Mart's second-quarter earnings rose 6% from a year ago to $2.8 billion, or 67 cents a share, on sales that jumped 10.2% to $76.8 billion. Analysts were expecting earnings of 65 cents a share on sales of $77 billion, on average.

Despite the upside on its bottom line, shares of Wal-Mart were down 84 cents, or 1.7%, to $48.26 in premarket trading. Investors were discouraged by the retailer's outlook for the third quarter, when it expects earnings between 55 and 59 cents a share on same-store sales of 3% to 5%. Analysts on Wall Street were expecting earnings of 60 cents a share for the period, according to consensus estimates reported by Thomson First Call.

Meanwhile, Wal-Mart left a wide range of possibilities open for its annual performance, projecting earnings between $2.63 and $2.70 a share. Analysts are expecting earnings of $2.66 a share. In 2004, Wal-Mart earned $2.41 a share.

"Right now, I believe that the middle of the range is reasonable," said Wal-Mart's chief financial officer, Tom Schoewe, on a conference call.

Wal-Mart's chief executive, Lee Scott, blamed the company's sales shortfall on high gasoline prices, which crimp spending particularly among its poorer customers. He also said rising pump prices present the company's biggest risk to its future performance.

"I do feel good about the economy, but I do worry about the effect of higher oil prices," Scott said.

By division, Wal-Mart's second-quarter sales rose 10.4% from a year ago to $51.81 billion at the flagship Wal-Mart Stores chain; rose 5.9% to $9.97 billion at Sam's Club; and rose 12.3% to $15.03 billion in Wal-Mart's international unit. In the U.S., same-store sales rose 3.5% from a year ago in the second quarter: 3.6% at Wal-Mart Stores and 2.9% at Sam's Club.

Its gross margin rate rose 25 basis points, but the company stressed that it did not achieve this by raising prices. It attributed the improvement to "global procurement and product mix."

Still, there were some cost concerns as sales, up 10.3%, rose faster than operating income, up 8.3%.

The company's net interest expense rose 5 basis points, and while Schoewe expressed confidence that inflation is under control in the U.S. economy, he indicated rising interest rates could be a problem for Wal-Mart. He noted that 50% of the company's debt is tied to so-called floating rates, which rise and fall in concert with the 10-year Treasury note. While rates have been at historical lows for years now, the

Fed

is attempting to rein in the money supply with 10 consecutive rate hikes of its federal funds rate.

"Rising interest rates will have an adverse effect on our borrowing costs," Schoewe said.

He also said utility expenses rose by $100 million in the quarter and fuel costs were up $30 million.

Aside from its performance, Wal-Mart said it would change the way it reports its performance to Wall Street, eliminating its policy of providing weekly sales updates.

"This is designed to focus investors on a longer time frame, which is more relevant because it averages out the impacts of weather and other short-term factors," Schoewe said.