Walmart's Massive Earnings Warning Underscores 2 Big Concerns

Updated from 8:29 a.m. ET to include further analysis based on the company's earnings conference call.

NEW YORK (TheStreet) -- Walmart (WMT) delivered a knockout punch to already bruised investors Thursday in the form of sluggish second-quarter earnings and a full-year earnings warning.

Two specific areas of the quarter report -- comments from executives on the sales performance of U.S. supercenters and global inventory levels -- should worry even the most long-term investor.  At the very least, each factor helps to explain the company's massive full-year earnings reduction from its prior expectations.

Walmart, which my firm Belus Capital Advisors rates a sell, announced second-quarter earnings of $1.21, in line to Wall Street estimates, and the mid-range of its $1.15 to $1.25 per share guidance. However, the profit figure could be viewed by the market as disappointing as Walmart issued below-consensus guidance when it reported first quarter earnings back on May 15. At the time, Walmart’s $1.15 to $1.21 per share guidance was below the then consensus forecast of $1.28.

"As it relates to our challenges in the quarter, we wanted to see stronger comps in Walmart U.S. and Sam’s Club, but both reported flat comp sales. Stronger sales in the U.S. businesses would’ve also helped our profit performance," noted Walmart CEO Doug McMillon in uncharacteristically blunt language.

Where were sales not the strongest? U.S. supercenters. Walmart U.S. President and CEO, Greg Foran, who officially began his new position on Aug. 9, stated: "In Q2, our supercenter fleet had a comp decline of approximately 30 basis points. We recognize the need to improve the performance and standards of this format to meet customers’ expectations. We plan to open, relocate, or expand about 115 supercenters for the fiscal year." 

Walmart increased its U.S. supercenter square footage by 10.34% in fiscal year 2014 compared to fiscal year 2011, as tabulated by Bloomberg.

Supercenter sales lagging the performance of Walmart's online sales growth, and sales increases at smaller format stores such as Neighborhood Market and Walmart Express, should be a source of concern for investors. Those statistics show a company struggling with heightened competition for low-income consumers from an array of foes, including Dollar Tree (DLTR), Family Dollar (FDO) and Kroger (KR), while also contending with Amazon (AMZN) amongst higher-income shoppers.

In the second-quarter, Walmart's Neighborhood Market concept realized a same-store sales increase of 5.6%, Walmart's Express concept sales were "solid" as noted by Foran, and Walmart's U.S. online sales were referred to as having increased by a "double-digit percentage." 

The poor performance of Walmart's supercenters, which are the largest component to the company's global square footage, are evidenced in return metrics.  Return on investment declined to 16.6% from 17.9% in the second-quarter. For the first-quarter, return on investment was 16.7%, down from 17.8% a year earlier. Per Bloomberg data, Walmart’s return on invested capital has gone from 14.61% in fiscal year 2011 to 13.02% in fiscal year 2014, as the company has invested in the aforementioned new supercenters, smaller store formats, and mobile initiatives.

Walmart forecasted full-year earnings per share of $4.90 to $5.15, a warning compared to prior guidance of $5.10 to $5.45. A lackluster outlook for the third quarter, which includes the important back to school selling season, contributed to the lowered full-year guidance. Walmart’s third-quarter earnings per share were guided to $1.10 to $1.20 by the company, where Wall Street was expecting $1.18 per share.  "Our guidance includes incremental investments in e-commerce and headwinds from higher health-care costs in the U.S. than previously estimated," the company said.  What went missing in the guidance details was the potential profit margin pressure as Walmart seeks to clean up its global inventory position.

In the U.S., inventory gained 5% year over year, quicker than the unchanged same-store sales result for the division.  International inventory "grew faster than sales" the company pointed out, and Sam's Club inventory rose 4.7% year over year, outpacing the division's unchanged same-store sales increase. Other intricate areas of concern for investors:

  • Walmart seemed to have slowed the pace of its share buybacks, repurchasing $307 million of its stock in the second-quarter. Given the earnings warning, Walmart moderating the pace of buybacks could signal to investors the company views operating challenges to persist into 2015 and beyond. In the first-quarter, Walmart repurchased $626 million of its stock. Over the past three fiscal years, the company has bought back $20.5 billion of its shares, according to Bloomberg data.
  • Operating profit margins declined by 40 basis points at Walmart U.S. year over year, pressured by investments in associate hours to improve customer service and merchandise stock levels. Same-store sales were still unchanged in spite of this investment.  "During the quarter, we also allocated additional associate hours to specific areas of the store, such as front end, deli, bakery, and overnight stocking to improve overall customer service. We also sustained incremental labor expenses related to major department re-lays in entertainment and sporting goods. In total, salaries and wages were up more than $200 million compared to last year", remarked Foran.
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At the time of publication, the author's firm rated Walmart shares a sell.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

-- By Brian Sozzi CEO of Belus Capital Advisors, analyst to TheStreet. This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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