Why the Rally in Walmart Stock Is Fading

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WMT stock - Why the Rally in Walmart Stock Is Fading

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Walmart (NYSE:WMT) has ridden quite the roller coaster of late. WMT stock rose just shy of $110 in late January, buoyed by a strong market and hopes that it was becoming a worthy competitor to Amazon.com (NASDAQ:AMZN). By May, the stock had dropped about 25%.

Disappointing Q4 earnings in February were a key driver. The Q1 report didn’t help much, either. It certainly didn’t seem like Amazon was at risk. Indeed, as Dana Blankenhorn argued, Walmart seemed to be losing to both Amazon and Costco (NASDAQ:COST).

Walmart then went and posted a blowout Q2. Suddenly, the company’s omnichannel strategy seemed to be working — again. U.S. comps were the company’s best in over a decade. WMT stock soared, touching $100.

Since then, investors have sold the news. WMT stock has dropped six out of the last seven sessions, falling over 5% from post-earnings highs.

That reaction seems somewhat incongruous in the context of the strong Q2 report and the potentially rehabilitated bull case for Walmart stock. But looking closer, the post-earnings weakness makes some sense. Walmart already is pricing in a decent amount of success, and it still has a lot of work left to do.

The Good News From Walmart Earnings

Again, it looks like Walmart is on the right track coming out of the Q2 report. EPS of $1.29 beat consensus by $0.07. Revenue growth was a point better than the Street projected. U.S. same-store sales rose 4.5%, which as noted was the best performance since before the financial crisis. Notably, Walmart gained 2 points on both traffic and ticket, showing broader strength.

Sam’s Club strengthened, posting a 5% comp. International sales rose 4%, and more than 3% on a constant-currency basis. Adjusted EPS guidance was raised to $4.90-$5.05, up from $4.75-$5.00.

Meanwhile, the omnichannel efforts once again appear to be working. It was weaker-than-expected e-commerce performance in Q4 — growth of “just” 23% — that spooked investors in February. In Q2, however, e-commerce sales rose 40%. And the company continued adding to its capabilities, adding automated pickup towers and expanding grocery pickup options.

If the WMT stock story is based on the company adapting to — and thriving in — the omnichannel era, Q2 seems to be good news. So why is WMT stock selling off?

The Concerns

There are two concerns I see coming out of the quarter. The first is that profits continue to head in the wrong direction despite the headline beat.

Operating income has declined the last three years and fell another 3%+ year-over-year in Q2. Wage increases are hitting operating expenses. Competition, from not only Amazon but Target (NYSE:TGT), Kroger (NYSE:KR) and many others, and Walmart’s longstanding dedication to lower prices are affecting gross margins.

There are some short-term impacts from those omnichannel investments, of course. Still, some of the pressures are more permanent (notably on the labor front). And pricing and margin pressure continues across the space, in both grocery and retail.

That leads to the second concern: valuation. WMT stock hardly looks expensive. After the modest pullback over the past few sessions, it trades at 19x the midpoint of FY19 EPS guidance. Against the market as a whole, that hardly seems like a steep price to pay.

But, again, Walmart’s space remains relatively challenged. TGT trades at 16x. KR is under 15x. COST and, of course, AMZN, trade at much more elevated valuations. But those companies aren’t posting sub-4% YOY revenue growth or declining operating income.

Walmart already is pricing in a return to profit growth — and consistent, steady profit growth. Q2 seems to show that growth is coming, but after two less-successful quarters, that change in trend hardly seems assured.

On the Sidelines With WMT Stock

From here, then, the pullback to the mid-90s makes some sense. For one, we’ve been here before with WMT stock — just seven months ago when it looked like Walmart was set to combat Amazon’s market share gains. Yes, a 4.5% comp is impressive. But Amazon grew revenue 37% in its fiscal second quarter, off a much larger base than Walmart’s e-commerce sales.

Secondly, 19x earnings is expensive in an industry where margins are thin and getting thinner.

That’s not to say WMT stock is a sell or a short. In fact, all else equal, I’d probably lean toward buying WMT at these levels (and indeed I’ve been bullish in the past). But I’d like a cheaper price or more confidence in the omnichannel efforts. Given the quarter and recent price action, in the next couple of months, it’s possible both may be on the way.

As of this writing, Vince Martin has no positions in any securities mentioned.

After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.


Article printed from InvestorPlace Media, https://investorplace.com/2018/08/why-the-rally-in-walmart-stock-is-fading/.

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