It has been clear in recent earnings seasons that companies in the S&P 500 are achieving growth in profitability thanks more to their ability to cut or keep a lid on their costs than to their success in boosting sales or revenues. With nine out every ten S&P 500 member having reported their results for the first quarter of 2013 as of the end of last week, that trend is intact, with Thomson Reuters reporting that while earnings growth is ahead of expectations, with those that have reported so far announcing a 5% increase in profits, the same companies also announced a small decrease in revenues.
If you’re an investor, you want a company to keep a keen eye on costs – especially labor costs, for many firms the single largest variable expense. With Wal-Mart Stores (WMT) the question of how much cost-cutting is too much may be back in the spotlight. If keeping a tight rein on labor costs in order to sustain profit margins takes a toll on service levels and customer satisfaction, the move could backfire. That’s especially true if, as a recent report from Bloomberg Businessweek suggests, when you do eventually reach the front of the increasingly long line at the cashier’s register, that cashier hasn’t received the training to properly handle your queries about price-matching guarantees or other special offers. There have also been questions about whether short-staffing of Wal-Mart stores has resulted in poorly stocked shelves.
The company’s fiscal first quarter results, released on Thursday, highlighted the squeeze it is facing. Its costs were higher than expected: its costs related to a bribery investigation totaled $73 million, nearly double its earlier estimates. (Congress, the Justice Department and regulators into allegations that the company resorted to bribery as it opened stores overseas, including claims that Wal-Mart execs handed out envelopes stuffed with cash to Mexican officials.) Growth in profits was an anemic 1.1%, and the company warned investors that its outlook is deteriorating slightly.
The primary reason for this is that Wal-Mart’s core customers – the blue-collar workers and lower middle class for whom every dollar of disposable income can make a visible difference to their lives – aren’t feeling the benefits from the muted economic recovery. To the extent that they are employed, their wages are largely stagnant or even declining, thanks to the higher payroll taxes, and their confidence that they will remain employed is muted. Their willingness to shop for anything but a clear bargain – the kinds of products on which Wal-mart enjoys only a razor-thin margin – is limited. Back in February, Wal-Mart’s outlook was already gloomy, as it predicted flat same-store sales. The reality proved still more downbeat, as U.S. same-store sales in the first quarter dipped 1.4%. “Our consumer is still stretched,” CFO Charles Holley told investors, adding that the company’s second quarter also appears as if it will be “challenging.”
Wal-Mart is a stock to consider on the merits of its business, which is hard-pressed right now; its dividend yield of about 2.4% and PE ratio of about 15 aren't all that compelling for bargain seekers. This is not the time to bet on a company’s ability to increase its profits by cutting costs, or to wager that a business that relies on hyper-price conscious consumers for sales to boost its revenues.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at email@example.com.
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