International growth

International growth is providing the earnings growth impetus for Walmart presently. The US consumer is spending very cautiously in the current environment, but the company is lifting its productivity to make gains. Walmart’s second quarter profit of $3,596 million was 3.4% ahead of the prior period. The company has raised its earnings guidance for the full year.

Walmart added over 3.2 million square feet of retail space to its international portfolio, an increase of 1.2%. The 4,200 international stores in 14 countries make up 28.2% of Walmart’s total worldwide footprint and 25% of group sales. Total sales from the international stores increased 11% in the second quarter to $12.4 billion with particularly good performance from Mexico, Brazil and China. Operating profit in this division also improved by 16.8% to almost $1.3 billion during the period.

Looking at the weekly chart of WMT we can see that the share price has pulled back to support at its long term uptrend. It broke below this level briefly but is now back above the uptrend and testing the 200 week moving average. The weekly MACD which had registered a sell signal earlier in the year now looks set to generate a buy signal.

Taking a closer look at the daily chart of WMT we can see that the recent price action looks to be forming a bullish inverse head and shoulders pattern. A break back above the recent downtrend and the horizontal resistance at the $52 level would complete this bullish pattern and generate an upside target of $56 which would coincide with the recent high of $56.

In the UK where Walmart owns supermarket chain Asda, second quarter same store sales were down 0.4% (excluding fuel) while total sales were up in low single digit territory. Asda has 377 supermarkets throughout the UK and is facing a similar consumer reticence to spend as in the US. Rising taxes and job losses are hurting consumer confidence making life difficult for retailers generally. Asda’s result was no different to its main rivals Tesco and Sainsbury’s who also reported soft result recently.

In May, Asda announced the acquisition of the 193 store Netto UK chain for £778 million as the group seeks to expand its presence in the non-food retail sector. Asda is also expanding its Asda Living stores to a target of 150 in five years as part of this strategy.

Within the US, total sales were flat at $64.6 billion for the quarter although same store sales (excluding fuel) declined 1.8% at Walmart discount stores, but rose 1.0% at Sam’s Club.

This is the fifth consecutive quarter of negative same store sales growth at Walmart US discount stores. The trend is not out of line with the rest of the retail industry but makes life difficult nonetheless for managers to shift inventory and encourage foot traffic and unit count. Walmart is moving back towards more everyday low pricing as its core strategy in an attempt to ‘leverage expenses’ as the company puts it. Empowering individual store managers to make local decisions on promotions and discounting is beginning to gain traction with an improving trend of sales throughout the quarter, albeit fractional.

Grocery improved both in foot traffic and in sales during the quarter even in the face of deflation in some categories. Fresh delivered double-digit comparative sales growth while other categories were hit by rollback pricing. Walmart US chief executive Bill Simon noted that the price discounting in May and June did not impact as much as anticipated so the company retreated to its tried and tested EDLP model in July.

Apparel is still struggling, as is home and hard lines, entertainment and automotive categories.

As the important back-to-school period approaches, Walmart is seeing customers shopping only for necessities and not being drawn into impulse purchasing of other goods. However, foot traffic through the stores is rapidly improving suggesting customers are at least getting out of the house and are in the stores. Converting the traffic growth into volume growth will be the immediate challenge at the store level.

Including fuel, sales at Sam’s Club grew 2.2% to $12.5 billion, with same store sales growing 1.0% excluding fuel, and 2.6% with fuel. Fresh and health categories were well patronised and even some seasonal categories picked up. Sam’s Club CEO Brian Cornell said deflation pressure is abating in some categories but remains a problem in others. In this regard, entertainment and technology categories were hit.

Walmart’s short term strategy is to remain uppermost in consumers’ minds that it is the destination for basic everyday necessities. Behind the scenes, the company is still focusing on reducing costs to provide the operating leverage it needs to lift earnings. In this regard it is achieving good success. Gross profit margin has not slipped across the same period that same store sales have. At 19.3% of total sales, the cost of doing business for Walmart has remained steady. Operating income has therefore improved by 4.4% over the quarter to 6.0%.

The heightened focus on cost containment is the first step, we believe, to Walmart delivering outperformance against its retail peers and the market generally as the US economy gradually recovers. We fully expect this period to cover an extended period of time, providing discount retailers like Walmart to thrive in such an environment. Evidence that this may already be bearing fruit was the company’s raised earnings guidance for the full year. Walmart is now expecting earnings per share between $3.95 and $4.05, ahead of the previous guidance range of $3.90 to $4.00 per share. At face value, this doesn’t appear earth shattering, but in the context of the US economy, we think this highlights the reason to be aboard a premium operator such as Walmart at this point of the economic cycle in the US.

We will continue to hold Walmart in the Fat Prophets Portfolio.