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Sturdy Comps a Key Driver for Walmart, Margin Woes Linger

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Walmart Inc. (WMT - Free Report) has seen its shares rally close to 14% in the past six months, pretty much in line with the industry. The company has been consistently gaining from its sturdy U.S. comps record, which, in turn, are being backed by Walmart’s efforts to boost both online and store sales. Though the company is grappling with soft margins, its solid sales drivers should help the company remain in investors’ good books.



Superb Comps Record — A Major Driver

Walmart has been gaining from its splendid comps record, which, in turn, is driven by the company’s constant expansion efforts and splendid e-commerce performance. Incidentally, Walmart has been undertaking several efforts to enhance merchandise assortments. Also, the company is on track with store remodeling, in an attempt to upgrade them with advanced in-store and digital innovations. Walmart is also gaining from its compelling pricing strategy, which helps the company draw customers.

Well, such trends drove the company in third-quarter fiscal 2019, which marked Walmart’s 17th consecutive quarter of positive U.S. comps growth. U.S. comps (excluding fuel) improved 3.4% on the back of a 1.2% rise in traffic and 2.2% in ticket. Management is encouraged about the rosy U.S. economic scenario, and is focused on boosting innovations and leveraging technology. Walmart is also hopeful about the holiday season, given consumers’ continued favorable response to its omnichannel offerings.

Incidentally, Walmart is trying every means to evolve with the changing consumer environment to compete with brick-and-mortar rivals and e-Commerce king Amazon (AMZN - Free Report) . In this regard, the company has been taking several e-commerce initiatives, including buyouts, alliances, and improved delivery and payment systems. To this end, the company’s strategic partnership with Microsoft (MSFT - Free Report) is likely to strengthen Walmart’s digital capabilities through the latter’s strength in providing advanced cloud solutions.

Also, Walmart concluded the buyout of 77% stake in Flipkart, which is included as part of the company’s results. Apart from this, the company’s buyouts of ShoeBuy, Moosejaw, Bonobos, ModCloth and Jet.com, and deals with Rakuten, and Lord and Taylor underscore its quest to build an impressive digital brand portfolio. The company’s plans to venture into the subscription-based video streaming arena, improve its website, conclude the deal with PayPal, launch Bonobos and Nike (NKE - Free Report) on Jet.com, enhance check-out process, and focus on Walmart2World money transfer service bode well. Also, its Walmart Pay mobile payment system and Mobile Express Returns program further highlight the company’s initiatives to accelerate online business, and make shopping easier and faster.  Apart from this, Walmart is making aggressive efforts to expand in the booming online grocery space, which was a major contributor to its e-commerce sales in the third quarter.

Will Strained Margins Be Offset?

While Walmart’s online strategies have been driving its business, costs associated with investments in e-commerce expansion and technological advancements, the mix impact from growing e-commerce operations and Walmart’s compelling pricing strategy have been weighing on its margins. Evidently, these factors caused the company’s gross margin to contract 11 bps, 29 bps and 61 bps in the second, third and fourth quarters of fiscal 2018, respectively. In first-quarter fiscal 2019, gross margin shrank 15 bps, followed by a 17 bps contraction witnessed in the second quarter.  During the third quarter, gross margin contracted 21 bps on account of price investments in various markets, elevated transportation expenses and e-commerce mix impacts. Management had earlier projected margins to remain pressurized in fiscal 2019. Further, investment in Flipkart is expected to raise Walmart’s interest expenses and hit the bottom line in fiscal 2019 and 2020. Nevertheless, the Flipkart deal is likely to be beneficial in the long run.

Considering all these factors and solid anticipations for the fourth quarter, the company raised its U.S. comps and adjusted earnings per share guidance for fiscal 2019. U.S. comps are now anticipated to grow at least 3% (excluding fuel) compared with roughly 3% growth expected earlier. Adjusted earnings are now expected to be $4.75-$4.85 per share, up from $4.65-$4.80 guided earlier. We expect such factors to continue driving this Zacks Rank #3 (Hold) stock.

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