Shifting consumer spending dinged Walmart (WMT) last quarter when rising food and gas prices forced customers to swap high-margin discretionary purchases for low-margin necessities. On Monday, Walmart warned it's already downbeat guidance for the second quarter and the full year wasn’t downbeat enough. It expects operating income to fall by over 10% this year, far worse than the 1% decline it forecasted in May.
It shouldn’t be surprising that Walmart (and likely, its competitors) are still struggling.
Crude oil and food prices spent most of the second quarter heading higher, and businesses are still passing along as much of their cost increases as possible to customers. As a result, consumers remain squeezed by declining real wages (wages minus inflation), which fell 3.6% year over year in June.
Unfortunately, wage growth is unlikely to re-accelerate soon because increasingly, more companies are shelving hiring plans and announcing layoffs. Initial jobless claims – first filings for unemployment benefits – have been trending higher since April, and average hours worked per week are falling. The combination of inflation and a shorter workweek means workers' average real average weekly income is down 4.4% compared to one year ago. As a result, Americans’ personal savings rate (savings as a percentage of disposable personal income) has fallen to 5.4%, the lowest since the Great Recession.
What Walmart said
The problem with consumer spending shifts is that inventory orders extrapolate past patterns. As a result, orders are slow to adjust to rapid changes in consumer behavior, resulting in bloated shelves. This dynamic forces retailers to slash prices to increase turnover, crushing margin.
In “Walmart Shakes Up the Macroeconomic Environment With Its Shocking Warning,” Real Money’s James DePorre notes, “In February, Walmart was expecting growth in earnings per share of around 5% to 6%. On Monday night, the EPS projection was changed to a decline of 10% to 12%.”
Oof! That kind of reversal only happens when retailers are caught flat-footed by a change in the economy. Remember, economists’ expected GDP to grow in Q1. Instead, it fell 1.6%.
Stephen Guilfoyle adds context in “Walmart's Woes, Standing Before the Payphones, Coinbase Crumbles, Yardeni's Call.” He writes:
“Walmart, in case you have been out of the loop, issued its second profit warning within a 10-week span on Monday, three weeks ahead of earnings. The company warned that operating income will fall 13% to 14% for the quarter and by 11% to 13% for the full year, as the discounting of what can only be described as inventory mismanagement is worked through.
Interestingly, Walmart now sees consolidated net sales up 7.5% (6% excluding fuel) for Q2 and up 4.5% for FY 2023, which is a boost from previous guidance of 5% and 4%, respectively. The problem is that while discounted inventories eat away at margin on one end, increased dollar value sales of groceries, which is a low-margin business to begin with, eat at the other end. Walmart sees adjusted EPS contracting 8% to 9% for the quarter and between 11% and 13% for the full year. Prior guidance had been for a full-year decline of approximately 1%.”
So, as DePorre notes, EPS estimates in February were for growth of 5% to 6%, and as Guilfoyle says, that fell to a 1% decline in May when it reported its first-quarter numbers. Now, it expects a double-digit decline in profit. What’s particularly notable is that, aside from Amazon (AMZN) , Walmart arguably has the best buying power on the planet.
In Walmart’s press release, management blamed the shortfall on “pricing actions aimed to improve inventory levels at Walmart and Sam’s Club in the U.S. and mix of sales.”
“Food inflation is double digits and higher than at the end of Q1. This is affecting customers’ ability to spend on general merchandise categories and requiring more markdowns to move through the inventory, particularly apparel. During the quarter, the company made progress reducing inventory, managing prices to reflect certain supply chain costs and inflation, and reducing storage costs associated with a backlog of shipping containers.”
It also said:
“The increasing levels of food and fuel inflation are affecting how customers spend, and while we’ve made good progress clearing hardline categories, apparel in Walmart U.S. is requiring more markdown dollars. We’re now anticipating more pressure on general merchandise in the back half [emphasis mine].”
Therefore, this is a demand problem driven by real wage declines and a “can’t market it down low enough to move it” problem that management worries will extend throughout the year.
Is Walmart a buy?
At some point, rising interest rates' negative impact on the economy will rein inflation, allowing the Fed to shift gears and hit the economic gas pedal again. The Fed’s dual mandate includes keeping unemployment low, so if job losses pick up in the back half of this year and inflation retreats, perhaps that sets up a friendly Fed (or at least a Fed on the sidelines) next year.
Unfortunately, while we have seen some relief in commodity prices since mid-June (oil and grain prices have fallen) and pressure is mounting in the jobs market, there’s not enough evidence yet to suggest that a shift in Fed policy is near. Perhaps, Q2 GDP on Thursday, and more inflation data (PCE) on Friday, will offer more clues, but we’ll likely need a few months of data for conviction.
The economy’s eventual stabilization and return to growth, coupled with the fact that Walmart's clearance pricing and adjusted orders will eventually get inventory back in check, may have you wondering if now’s a good time to buy.
In “Walmart Exposes Itself: But Is That a Real Bottom We're Seeing?” Top Stocks technical expert Helene Meisler offers her take on if it’s a buy.
She writes: “It has had a decent rally off the lows -- about 12%, but step back and look where it rallied to: resistance. Now step back and consider that the 9-plus months prior to the May gap down (on similar news to what we saw on Monday after the bell) was the top. Recall my view that typically if the top took 9 months to build then the base should take a similar amount of time -- at the very least. So with Walmart two months into what might be a base -- we don't know if it's a base or a way station -- how can anyone say the bottom is in with any confidence?
A climb after its steep drop in May isn’t surprising, but short bases aren’t standard in bear markets. It takes time and a lot of ‘churn’ to work through sellers trapped above who view each rally as a “phew, get me out” opportunity.
What could get Meisler more bullish on Walmart’s chart? Time.
Back to Meisler:
“Let's say Walmart comes down on Tuesday into that $120 area, and over the course of the next few days, it holds over $118-$120 -- it is an area, not an exact level, which was the same place it held in May and June. And let's say it starts to trade something like I have drawn in blue over the next two to three months, isn't that what base building looks like? Doesn't that look more like a base than what we've seen in the mere two months since May?
All I'm saying is that this is how bases should form. There should be a series, not one or two, but an entire series of back-and-forth moves that tell us where the buyers live. It tells us -- several times -- what price area buyers are willing to step up to the plate at. It also tells us where they want to sell the first several times as well.”
Meisler shares the following chart to illustrate her point. As you can see, if Walmart holds the area near its prior low, it could “chop” about as value investors and bargain hunters work through all those trapped sellers. Of course, that process takes time and may not look anything like what Meisler has drawn. But, hopefully, you get the point. Recoveries in bear markets aren’t rapid “V” shaped rallies. Instead, they build upon drawn-out sideways bases.
The Smart Play
I believe we’re not out of the woods yet, so Walmart’s customers are likely to continue feeling the pinch.
In May, I wrote in “Are Walmart and Target Bargain-Bin Buys, Or Are They Too Risky?”:
“Short-term active traders may scalp a few dollars from an oversold bounce, but a wait-and-see approach may be best for most investors, given the Fed's tightening screws until GDP slows enough to tame inflation. I suspect the Fed will succeed, and eventually, discretionary stocks will benefit from a shift to the early stage of the business cycle again, but that will take time. While we wait, Walmart and Target can get their costs under control, and shares can establish actionable bases to build on.”
That advice remains true today. However, if you are interested in buying Walmart, make sure to run a stop loss under the position to contain your losses.
Alternatively, a better option may be to consider other retailers selling off in sympathy with Walmart that are arguably more insulated against slowing retail sales caused by a recession.
For example, a significant amount of Costco's (COST) and BJ Wholesale’s (BJ) profit is from membership fees, and their customers lean toward a wealthier demographic than Walmart. Alternatively, Dollar General (DG) and Dollar Tree (DLTR) tend to benefit from consumers shifting “down” from pricier stores during a recession. Also, a company that profits from buying bloated inventories, such as Ollie’s Bargain Outlet (OLLI) , is an option.