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Wal-Mart Uses Rigorous Cost Control To Offset Weaker Sales

Stephen D. Simpson, CFA

It's no secret that a meaningful percentage of the country's retail business goes on under the roof of Wal-Mart 's (NYSE:WMT) stores. To that end, when consumers are feeling pressure (particularly those on the less affluent side of the ledger) it shows up in Wal-Mart's numbers. This gigantic retailer didn't have a bad fiscal first quarter, and it sounds like the fiscal year ahead should get better, but once again Wal-Mart is having to turn to operating synergies to wring out some growth. This stock's status as a proxy for the U.S. retailing sector makes talk of value somewhat moot, but these shares don't look notably cheap on a long-term basis.

A Tough Selling Environment Pressures The First Quarter

Wal-Mart reported just 1% revenue growth for the first fiscal quarter, though underlying constant currency growth was a little more robust at nearly 2% and last year's leap day weighed on the growth by almost a full point.

Sales for Wal-Mart's U.S. stores rose barely at all, and so too for Sam's Club (though sales were up about 0.5% excluding fuel). Sales in Wal-Mart's international operations were up about 3% as reported and more than 5% in constant currency terms. On a same-store basis, though, U.S. comps declined about 1% with a nearly 2% decline in traffic. Sales were relatively stronger in essentials like groceries and weaker in more discretionary areas like entertainment and apparel.

Fierce efficiency has long been a hallmark of Wal-Mart (and a source of frequent criticism), and that helped deliver better results once again. Gross margin ticked up about 10bp, as the company's reinvestments into price haven't really fully kicked into gear. Operating income rose about 1%, with the operating margin basically holding steady.

Will It Get Any Easier From Here?

Wal-Mart cited several factors at play in the first quarter. Due to the last-minute changes in the tax code, refunds came a little later this year and that seemed to impact the quarter to some extent. Likewise, customers found themselves with less disposable income after the payroll tax increase, and I would expect this to show up in the results of other discount chains like Target (NYSE:TGT) and Dollar General (NYSE:DG).

As it stands today, I don't see any particular reason to expect a big rebound. The new payroll tax isn't going away anytime soon, and the “here today/gone tomorrow” nature of improvements in economic statistics like unemployment/job growth, wage growth, and consumer confidence don't speak to a big surge in demand anytime soon. Moreover, with over 50% of store revenue coming from groceries, improvements would be a little muted anyway, though in-store efforts to improve areas like produce should help at least incrementally.

I've seen some analysts also speculate that Wal-Mart could be at risk from renewed turnaround/improvement efforts at retailers like Kohl's (NYSE:KSS) and JC Penney (NYSE:JCP). I don't exactly doubt that Wal-Mart has benefited from Penney's failures, but it seems like there's always somebody doing better or worse at any given point in the cycle.

The Bottom Line

I still prefer Wal-Mart's international operations to their U.S. business. Likewise, I'm more interested in foreign-based retailers like CBD (NYSE:CBD) and ASOS (OTCBB:ASOMY), mostly because you don't have to go out quite as many decimal places to discern real opportunities in revenue growth or margin expansion.

As I said earlier, Wal-Mart's huge size within the retail sector makes it effectively a proxy trade on the retail sector and investor confidence in that sector. Consequently, the fact that even a long-term growth forecast of 8% for free cash flow only suggests a fair value in the mid-$70s doesn't lead me to believe that the stock couldn't go higher if or when investors feel better about the U.S. economy.

At the time of writing, Stephen Simpson did not own any shares in any of the companies mentioned in this article.

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