Rumors of Wal-Mart's Demise are Greatly Exaggerated
It's no secret that Wal-Mart has run into trouble in the last few years, following decades of steady growth. Last year, comparable-store sales fell 0.6% for the big-box retailer's U.S. division, which represents more than half of Wal-Mart's total revenue. Company-wide revenue grew just 1.6% in 2013.
My Foolish colleague Travis Hoium recently claimed that Wal-Mart is "falling apart," but that's quite an exaggeration. Over the long term, I don't expect Wal-Mart to generate same-store sales gains above the rate of GDP growth. However, the company should still produce steady long-term earnings-per-share growth as it leverages its unrivaled scale to offer low prices while maintaining a solid profit margin.
Stagnation in the USA?
I'll focus on the Wal-Mart U.S. division here, since it is by far the largest business segment, and it also posted the biggest decline in segment operating income last quarter (down 4.3%). Wal-Mart U.S. saw a modest comparable-store sales decline of 0.1% last quarter.
That number isn't as bad as it looks. Severe weather cut into sales during the quarter, especially in February -- without that headwind, comparable-store sales would have risen 0.1% during the period. Wal-Mart also estimates that reductions in the federal food stamp program last fall hurt sales growth by 0.5 percentage points.
The decline in U.S. operating income was not especially indicative of a longer-term trend, either. Unusually cold weather led to higher heating costs, while winter storms increased snow removal expenses and disrupted the Wal-Mart U.S. supply chain, driving incremental expenses.
The total impact of severe weather on Wal-Mart U.S. profit was approximately $120 million, accounting for more than half of the decline in the segment's operating profit. Wal-Mart U.S. saw another $110 million hit from higher health-care costs, which explains the remainder of the drop in segment operating income.
A turnaround is coming
Even ignoring bad weather and other unusual items, Wal-Mart's results in the U.S. are clearly nothing to write home about. Company executives have recognized that customers are only willing to come to a Wal-Mart Supercenter a few times a month, preferring to shop in more manageable stores in between those visits.
Accordingly, earlier this year the company announced plans to accelerate the rollout of two smaller format chains: Neighborhood Market and Wal-Mart Express. Wal-Mart Neighborhood Markets have an average size of 38,000 square feet and are designed to compete with regular supermarkets. Wal-Mart Express stores are just 15,000 square feet on average and compete more directly with dollar stores.
These two smaller formats have generated consistently strong comparable-store sales growth. Last quarter, while sales fell at the traditional supercenters, Wal-Mart Neighborhood Market comparable-store sales rose 5%.
Investors will need to be patient
It will take a while for Wal-Mart's move into smaller-format stores to pay off. Wal-Mart opened just 14 such locations last quarter, compared to a target for the full year of 270-300. The vast majority of the store openings will occur in the second half of the year.
Furthermore, small formats currently represent about 2.5% of the total Wal-Mart U.S. square footage. By year-end, that percentage might reach 3.5%. In other words, it will still be a very small part of the total.
However, Wal-Mart can further accelerate its small-format store rollout in future years. Adding locations will directly drive sales growth, and as small-format stores become a larger proportion of the total Wal-Mart U.S. footprint, they will begin contributing to overall comparable-store sales growth.
If Wal-Mart's new emphasis on small-format stores is successful, company sales growth in the U.S. should improve in the next five years. Given the company's size, it's probably unrealistic to expect long-term sales growth above 3%-5%. That would still be a big improvement over what the company achieved last year and what it is on pace to do this year, though.
If revenue begins growing somewhat more quickly, Wal-Mart U.S. should be able to gradually leverage expenses, reversing the recent drop in its operating margin. While there is no guarantee that this rosy scenario will play out, Wal-Mart's management has a credible plan to get there, and the early results have been promising. It's crunch time for Wal-Mart, but this retail giant is definitely not dead yet.
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The article Rumors of Wal-Mart's Demise are Greatly Exaggerated originally appeared on Fool.com.Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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